The razor’s edge deficit theory

Unlock the Editor’s Digest for free

Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

Good morning. The World Bank’s latest economic outlook, out yesterday, further downgraded global growth to 2.3 per cent this year — the weakest performance in 17 years, with pain felt most acutely in developing economies. The leading cause: trade disruptions, specifically Donald Trump’s tariffs. Disagree? Email us: unhedged@ft.com.

The razor’s edge deficit

Back in 2021 I wrote a couple of pieces about the link between the global savings glut and slower growth, low interest rates, and entrenched inequality. A lot of my comments were based on the arguments of the economists Atif Mian, Ludwig Straub and Amir Sufi.

The Mian-Straub-Sufi story goes roughly like this. The global rich have grown much richer in recent decades, leaving them with a pile of savings that has to go somewhere; for reasons that are not clear, the surpluses have not been transformed into productive investment, but have instead been loaned out to support consumption by the less rich; this supply of lendable capital has kept interest rates low, and therefore risk asset valuations high, making the rich richer and leaving them with still more savings to lend; but the increasing burden of interest payments saps demand.

It’s a compelling thesis. But I wondered recently whether the argument held up after 2022, when interest rates took a big step up, and stayed there. So I called Mian and asked him if his views had changed. It turns out the crucial addition to his view concerns the role of government borrowing in absorbing and propagating the savings glut.

At a macro level, the key thing to understand about an economy dominated by a savings glut is that the growth rate of consumers’ incomes (call it g) must stay above the rate at which they are borrowing (call it r). If it doesn’t, the consumers go bust. But in recent years, Mian says:

The rate the consumers borrow at is certainly above the growth rate for their incomes . . . No economy is sustainable with permanent defaults, so the economy tends to adjust to prevent default. When r rises above g, rates will be pushed down. The reason people borrowed in the first place is because there is excess savings in the finance system. So the system looks for people to borrow at a new, lower rate.

But as rates approach zero, this adjustment stops working. You can’t lower rates further and preserve profits for the lenders. At this point, the debt-addicted economy struggles to generate enough demand to stay out of a recession. The economy is in a liquidity trap. But there is one borrower that can borrow at a rate below its growth rate — the government. That is why the US primary deficit as a percentage of GDP has had to grow steadily, and exploded after 2008. Mian’s chart:

There is a problem, however. The government has to increase its deficit to keep the economy from stalling, but if it increases the deficit too much, then interest costs rise and growth slows. Mian and his co-authors call this the Goldilocks theory of fiscal deficits.

The private sector can’t borrow more and is stuck in permanent recession unless the government, with its r less than g, comes in. The government, by running a permanent deficit, can get you out of the liquidity trap — but you need a perfectly engineered government that runs a deficit big enough to avoid the liquidity trap, but not so big that r starts to creep up.

I’d suggest the term “razor’s edge deficit”, because it gives a sense of the stakes for Unhedged’s area of interest — markets. If the Mian-Straub-Sufi model of the economy is right, then we should plan for more volatility in debt and equity markets. As governments walk the razor’s edge that separates an insufficient fiscal impulse from higher inflation and rates, they will frequently slip to one side or the other.

Legacy media’s perpetual reorganisation machine

Legacy media companies are struggling. Cable networks, once a cash flow machine, are in decline. In the streaming business — cable’s replacement — it’s tough to compete with Netflix and make a profit. Shares of Warner Brothers Discovery and Paramount have lost roughly half their value over the past five years. Comcast is down around 10 per cent, and Disney up less than 3 per cent during the period:

So it’s no surprise that Warner Bros Discovery and Comcast are planning to offload their cable networks. The companies say this will let them focus on their strengths. And for decades the media industry’s preferred solution to any problem, or lack of problem, is to do a deal. WBD is separating its streaming and studios business (“StreamCo”, which includes HBO Max) from its cable networks (“Global Networks”), undoing a costly 2022 merger. Similarly, Comcast’s spinco, Versant, breaks off almost all its cable networks from the rest of NBCUniversal, which keeps theme parks, broadcast television and the movie studio.

The separation does not solve the fundamental problems, though: difficulties achieving strong profitability in streaming and the decline in the cable networks. The volatility of the streaming business means that even the higher-growth potential streaming companies may not achieve very high valuations, Kannan Venkateshwar of Barclays notes. High debt levels will only add to the volatility. Warner Bros Discovery carries about $37bn of gross debt. According to Venkateshwar, “neither entity will have enough ebitda to absorb this on a standalone basis without a significant increase in leverage”.

So what’s the next move?

Private equity could take the cable spin-offs private and milk them for cash — of which they still generate a good deal (it is hard to tell how much, exactly; Warner only reports segment “adjusted ebitda”, a metric best ignored). But Laurent Yoon at Bernstein told Unhedged that many media companies have gone through cost-cutting exercises in recent years, leaving less savings for PE to capture. There would, however, be more savings to capture if the new standalone networks companies were to combine, he said. So if Global Networks were to combine with Versant, they would become juicier PE targets. And if Warner and Comcast’s streaming operations were to merge, they could have more depth of content to compete with Netflix.

The transition from the old cable distribution to streaming was always going to be a grind; it is reminiscent of the painful newspaper-to-online transition for print media. Reorganisation can take some of the pain out of it. But not much.

(Kim)

One Good Read

Disenlightenment.

FT Unhedged podcast

Can’t get enough of Unhedged? Listen to our new podcast, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.