Why not more spending at low rates

by Morton Sosland
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When Glencore International P.L.C. and Xstrata P.L.C. announced earlier this year an agreement for Glencore to acquire Xstrata, the immensity of the undertaking made it comparable to how the food industry might look upon one of the major international trading companies acquiring Kraft Foods Inc. or Unilever P.L.C. Without comparing revenues, profits or invested capital, the deal that will create the new Glencore Xstrata P.L.C. establishes a business with global revenues exceeding $200 billion. In its simplest form, the merger combines the global trading business of Glencore in energy, metals and farm products (mainly grains and sugar) with Xstrata’s coal, copper and zinc mines as well as a major position in coal exporting. One investment analyst, in praising the joining of these two companies, pointed to their great “intellectual firepower.”

A merger like this, involving a share exchange valued at more than $40 billion, also goes a considerable way toward signaling revival in merger and acquisition activity, not just in mining, but also in food and related commodities as well as industry in general. Hardly any recovery in the wake of a financial collapse has been slower than that experienced in the recent period since the 2007-08 debacle. The food industry, once a hotbed of companies joining to build distribution, marketing and financial strength, has been relatively quiet for a longer period than normal. Indeed, the food industry probably has seen more spinoffs and divisions of companies than mergers meant to build larger enterprises.

Along with the full measure of caution when it comes to capital expenditures aimed at internal expansion, the quiet of the current period cries out for explanation. Even as many companies have moved to take advantage of interest rates at historical lows, others have displayed a degree of caution that obviously reflects not just brakes on the lending side, but also on the borrowing side. Instead of the aggressive borrowing attitude that might be expected at a time when interest rates are this low and when the Federal Reserve expects these to continue through 2014, hesitancy has ruled to a degree that appears almost without explanation. This atmosphere prevails in the food manufacturing industry, just as it affects the pace across nearly all American industry.

In looking for an explanation that would provide a satisfactory answer, the temptation is great to turn to a recent analysis by Bill Gross, founder and chief investment officer of Pimco. Mr. Gross, one of the most respected participants in fixed income markets, writes in the Financial Times about the “liquidity trap.” He focuses on the disincentive for lenders to extend intermediate or long-term credits without either a yield premium or “sufficient downside room for yields to fall and bond prices to rise,” producing capital gains.

In the past, flat yield curves like those currently ruling did not stand in the way of business because real rates were usually quite high and thus had room to fall. This was an incentive to extending credit for investment purposes and to stimulate demand. But the present-day flat yield curve is accompanied by what Mr. Gross calls “zero-bound yields,” which have little or no room to fall and thus offer no incentive. As examples, he cites two- or three-year Treasury bonds priced below the 25 basis points offered overnight by the Federal Reserve, and five-year Treasuries at 75 basis points when the rate itself of 2% offers a possible minimal capital gain on declines and “substantially more” loss possibilities on any advance.

Understanding the reluctance of banks and other credit providers to be active pursuers of borrowers does not dismiss the opportunities available to well-established companies in industries like food manufacturing. Sure, a credit provider may be more cautious than previously, but that does not rule out taking advantage of this zero-bound world where the cost of investing to improve and expand a business ought to be a genuine enticement to move.
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