Wednesday, 26 November 2008

The cost of equity, huge government deficits and investment

Suppose a firm wanted to expand and fund some new investment, say in some new equipment. It could raise the money by a) borrowing from the bank, b) using some of its past profiits, c) issuing corporate bonds, or d) issuing new equity (i.e. shares).

The Bank of England provide a handy little data series tracking the cost of that last option. They published the series in their last inflation report, and it is republished in the above chart.

The message from the data is simple enough; firms are finding it increasingly costly to fund new investment through equity issuance. This is how the Bank of England described the situation:

"Conditions in the corporate debt and equity markets have also worsened significantly since the August Report, as the economic outlook deteriorated and investors’ appetite for risk diminished. International equity prices fell, driving up the cost of corporate equity issuance."

As for the other options; yields on corporate bonds have also risen, while corporate profitability has taken a dive. This leaves bank lending, and we all know what has happened there.

If firms do not invest, it is hard to see how the economy can sustainably grow. Encouraging the debt-serfs to buy crap doesn't directly increase the productive capacity of the UK economy.

This brings us back to Darling's borrowing binge; if the government borrows around 8.5 percent of GDP next year, then long term interest rates will rise, crowding out private sector investment. How will huge governmetn deficits improve "investors appetite for risk"?


Anonymous said...

A budget for British business from Darling and Brown: Too little, far too late
By Chris Marsden
26 November 2008

Have fun!!!!


Capital is reckless of the health or length of life of the laborer, unless under compulsion from society.

Karl Marx

Nick von Mises said...

The labourer is reckless of the whims or diktats of the bureaucrat, unless under compulsion of a commissar

Nick von Mises

Nick von Mises said...

BTW, if the market is saying "don't expand, it'll lose money" why can't government take the hint.

That's what market interest rates do. It's why central banking and government interference is a disgrace.

K T Cat said...

if the government borrows around 8.5 percent of GDP next year, then long term interest rates will rise, crowding out private sector investment.

This is where I'm at, too. If that's the case, you want to invest in companies that already have cash, like MSFT. Companies like that will be more like banks than anything else, able to lend money when no one else can.

I'm just at the beginning of learning about this stuff, so don't take my MSFT example as an endorsement. It's just an example.

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Moshe said...

Hey man you are totally right about the equity funding and thanks for sharing the post with us and it really was an informative blog and I liked it.