How to lie with data, edition 1,000,007 -- corporate debt to gdp

In yesterday's NBR show, the host showed the following graph of corporate debt to GDP:

He pointed out (1) peaks in the graph coincided with recessions and (2) "now we seem to be at a peak again," in both cases, implying that these debt levels suggest a recession is surely on its way.

Putting aside other causes of recessions, and not making a call on the possibility of a recession, both these points are mistakes, mistakes common to the interpretation of many data series. There also is another issue with the graph.

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On the first point, one should never confuse cause and effect. What most likely is happening is investors' appetite for debt falls during, and in the immediate aftermath of, recessions. Thus, companies cannot issue new debt and corporate debt levels naturally fall. In other words, it is far more likely that it is not the debt causing recessions, but the recessions causing debt levels to fall.

On the second point, there is simply no way to determine in a time series, with no intrinsic a priori natural maximal level, when you are at a peak, until well after the peak. That small declining squiggle could be important or completely irrelevant. Note there was a similar squiggle a bit earlier.

Finally, note the range on the y-axis. The range is too small. By using a small range, the graph looks much more dramatic, though misleading.

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What is most likely happening is with interest rates so low and starting to rise, companies are taking on debt, very likely, long-duration debt. Many companies, in particular large and stable businesses, can and should do this.

Debt has two general concerns -- one is the interest paid and the other is the principal. As interest rates are so low, companies likely have enough cash flow to pay the interest. Even when cash flow levels fall during a recession, with interest rates so low, interest payments are manageable, and companies likely have an ample buffer. Principal is a more serious concern and can put companies out of business in a hurry. Here, intelligent debt management matters. Debt maturities must be spread out, for instance.

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The irony in all this is this variable is very likely not the right statistic, at all. After all, cash may be thought of as negative debt. Thus, net debt, equal to debt minus cash, is far more interesting and relevant. Companies likely have staggeringly large cash balances these days.