The surest way to a reversal of financial fortunes is through negative cash flow (spending more than you earn). And over the past couple of years, cash flow has been plunging all over a highly levered (indebted) world.
The first natural response is to draw down cash reserves (savings), cut non-essential spending, tap available credit and sell assets (disposals) where possible. All options are finite. Beyond these, continued negative cash flow is the universal cancer that ends solvency for households, companies and countries. This chart from oil giant BP yesterday clearly demonstrates the math of revenues that crashed by more than half in 6 months. See: One simple chart that shows the problems facing big oil.
Thanks to decades of taxpayer subsidies and preferential political and regulatory advantage, BP has more stored fat than most. In the short run, it may also be able to further cut capital investments in its business. But if oil prices are not bouncing back soon, dividend cuts to shareholders are the next obvious ‘non-essential spending’ up for the chopping block. And it is not just oil companies that will be eying these.
The trouble is that over the past few years as interest rates flat-lined, investors with low risk-tolerance have increasingly herded into highly valued shares on the promise of dividend yields. They are dangerously banking on those promises now to sustain their own spending needs. This was always a bad plan.
Dividend cuts will prompt further cash flow reduction and thus spending cuts for customers, which will mean even less revenue for companies, further cuts, and so on. In a world that has grown accustomed to spending more than it should, the new normal of falling income is a huge adjustment.