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In the world of finance, something has been haunting economists and investors alike: zombie firms. The Fed has created hordes of zombie firms, with a study in April 2021 finding that over 25% of U.S. companies were zombies in 2020. These undead firms have been sucking the life out of the economy.
But things are about to get rough for the zombie hordes. They face potential extinction from the same entity that created them in the first place, i.e. the Federal Reserve. We unpack how the Fed, as part of its brilliant central plan to stabilize the economy, spawned hordes of zombies only to kill them off.
What is a Zombie Firm/Corporation?
So, what exactly is a zombie firm? These are companies that are alive, but dead, literally. Dead because their profits aren’t enough to cover the interest expense on their debt (they’ve long forgotten about making any principal payments). Alive, at least artificially, only because of the Fed’s sustained policy of low-interest rates and easy credit. They have no real growth prospects, and the only way they can survive is by rolling their debt at ever-lower interest rates.
What Could Kill A Zombie Company?
The economic weapons that could kill a zombie company off include a sudden increase in interest rates and a sharp decline in market prospects. In a rising interest rate environment zombie firms can no longer roll their debts at artificially low rates, and must now roll at increasingly higher rates, if they can even roll at all. This leads to a death spiral where their expenses are greater than their revenues which ends in eventual bankruptcy.
When a zombie firm goes under, it can cause a chain reaction of defaults and bankruptcies, unemployment for those formerly employed by the zombie firms, and a reduction in the supply of goods and services produced by zombies. We’ve written about what a chain of defaults might do to the price of gold and silver.
How are Zombie Firms Still Standing?
So why aren’t we seeing zombies dropping like flies right now? This is where the concepts of leading and lagging indicators come into play. A leading indicator is a signal that suggests a change in general economic activity is about to happen. A lagging indicator, on the other hand, is a signal that only shows up later, once the policy has made a direct hit, detonated, and its blast radius confirmed.
In the case of the Fed’s hiking interest rates, each zombie firm has different debt terms and maturities, which roll at different times. We wouldn’t expect any zombie to be chomping at the proverbial piece of flesh to roll their debt at higher rates. They would not do this, unless there were no other choice. If and when they do, that’s when you would see the disastrous effects of this policy in full effect.
Perverse Policies Produce Perverse Outcomes
As we have seen time, and time again, the Fed’s policies sow the seeds of destruction, no matter which way they turn. In the case of Zombies, the Fed’s rate hikes kill and create simultaneously. As the old Zombies die off from the higher rates, new ones are created by the higher interest rate hurdle. Companies that had enough profit to cover the interest expense on their debt at the lower rates, may not have enough to cover it at higher rates. They were teetering on the margin, but are now suddenly plunged into zombie firm status. It’s a vicious cycle that produces price stability and maximum sustainable employment benefits no one and only weakens the economy. The death of these zombie firms will lead to defaults, layoffs, and potentially more inflation. The Fed’s policy turns viable firms into brain-munching zombies, who will then employ people for businesses that have no business being in business.
The Silver (and Gold!) Bullet?
While traditionally only effective against vampires, werewolves, and witches, is there a silver (or gold!) bullet for these Zombie policies? What impact does the zombification of the economy have on gold and silver prices?
If zombies start dying off, this will surely have an effect on the labor market, which affects wages and consumer spending, which in turn affects broader economic measures. It’s almost as if, like, it’s all connected or something…
Anyway, labor indicators have a surprising relationship to silver prices, which we discuss in greater depth in our Gold Outlook Report 2023, in addition to our predictions for the likely direction of gold and silver prices under different economic scenarios.
Powell may be the creator and killer of zombies, but the real victims are the businesses and individuals caught in the crossfire. For more dynamics of the zombie economy, check out our Zombie month series on our YouTube channel. Stay safe out there!
In a debt bubble, the purchasing power of gold goes down. In a debt bust, the purchasing power of gold goes up.
I accept that the demand for credit from the private sector will fall but what about the demand for credit from the public sector – isn’t the narrative about the US having to borrow to finance its deficit and QT?
Totally agree, David B! The demand from government is endless.
A glaring omission from the discussion: The Risk of Default. That alone can and does cause rates to move up substantially, even it is against prevailing trend.
Truth is, the Risk of Default is becoming more real by the day, as markets look ahead.
Question: As the years whiz by and the empty promises of government come into full view, will the Risk of Default go up or down?
Exactly.
If you think the Treasury will default, do you prefer to own the Federal Reserve Note?
Fundamental price…. DOWN $41! Take note, Grasshoppers. Almost as if Fundamental is following the market, rather than leading the market, exactly as I have proposed for 3+ years.
The following episode will be quite interesting. The dollar price of gold is precariously perched near perceived support around $1,300, though perhaps as low as $1,260, especially on a monthly closing basis. If gold should manage to drop and stay below those two support levels for an extended period, the Fundamental price should collapse…. if it takes even that long.
Or is the elevated and sustained Fundamental price warning of an eventual spike to $1,400+? We’ll see, because that’s a possibility too. And what would be MOST interesting is seeing the dollar price rise to $1,400+ while the Fundamental DROPS below $1,350.
That would suggest the gold rally would end below $1,500 gold max (probably below $1,450) and a renewed bear market in a deflationary collapse to who knows where. But a sub-$1,000 price is certainly on the table…. which would be the buy of a lifetime, only to be surpassed by the opportunity presented by the early 1970’s. (If that scenario would unfold, $750 – $900 would be my guess)
Second question — at what point would the faithful few here at Monetary Metals sell their gold? Once you answer that question you will better understand where the bottom might be.
One key factor to keep in mind: Gold performs best when people are losing confidence in government. That’s really not happening on a widespread scale at the moment. But stayed tuned… we know the debts cannot be paid, and when default is plain to see the dollar (backed by nothing except faith) will begin its long decent to intrinsic value.