In several previous posts
I have looked at the apparent conundrum of rising/record profits in the US and some other major economies, with corporations apparently ‘awash with cash’, but still not investing enough in the ‘real economy’ to achieve a sustained recovery.
Various reasons for this have been presented. The two main ones that I have argued for are 1) profits are not the same as profitability and in most major economies profitability (as measured against the stock of capital invested) has not returned to levels seen before Great Recession and 2) such was the leveraging of debt by corporations before the crisis started that this is acting as a disincentive to invest and/or borrow more to invest, even for companies with sizeable amounts of cash. Corporations have used their cash to pay down debt, buy back their shares and boost share prices, or increase dividends and continue to pay large bonuses (in the financial sector) rather than invest in productive equipment, structures or innovations.
First, let’s be clear on the current situation. Take the US. The level of corporate fixed investment as a share of corporate cash flow is at 25-year lows. In previous posts (see above) I have highlighted that this is also a phenomenon to be found in Canada and the UK.
But an important point is that this apparent ‘hoarding’ began well before the Great Recession, with studies showing that companies see investment as too risky compared to the likely returns, particularly in new techniques (see above post). And as I have shown in previous posts, profitability is nowhere near levels achieved in the 1990s or in the credit boom period of 2002-6 as this graph on the UK corporate rate of return shows.
I have now done a little research on the US corporate sector and discovered that this ‘awash with cash’ argument has a lot more holes in it.
Much has been made in the financial media of the huge cash reserves built up by the likes of Apple or Google, although most of this cash is held overseas in tax-havens like Luxembourg. But it is true that cash reserves in US companies have reached record levels, at just under $2trn. (All figures come from the US Federal Reserve’s flow of funds data.) The rise in cash looks dramatic, especially in the last year. But also note that this cash story did not really start until the mid-1990s. In the glorious days of the 1950s and 1960s when profitability was much higher, there was no cash build-up
But the graph is misleading. It is just measuring liquid assets (cash and those assets that can be quickly converted into cash). Companies were also expanding all their financial assets (stocks, bonds, insurance etc). When we compare the ratio of liquid assets to total financial assets, we see a different story.
US companies reduced their liquidity ratios in the Golden Age of the 1950s and 1960 to invest more or buy stocks. That stopped in the neoliberal period but there was still no big rise in cash reserves compared to other financial holdings. And that includes the apparent burst in cash in the last year. The ratio of liquid assets to total financial assets is about the same as it was in the early 1980s. That tells us that corporate profits may have been diverted from real investment into financial assets, but not particularly into cash.
I also compared corporate cash holdings to investment in the real economy and I found that there has been a rise in the ratio of cash to investment. But that ratio is still below where it was at the beginning of the 1950s.
Why does that cash to investment ratio rise after the 1980s? Well, it is not because of a fast rise in cash holdings but because the growth of investment in the real economy slowed in the neoliberal period. The average growth in cash reserves from the 1980s to now has been 7.8% a year, which is actually slower than the growth rate of all financial assets at 8.6% a year. But business investment has increased at only 5.3% a year, so the ratio of cash to investment has risen.
Interestingly, if we compare the growth rates since the start of the Great Recession in 2008, we find that corporate cash has risen at a much slower pace (because there ain’t so much cash around!) at 3.9% yoy. That’s slightly faster than the rise in total financial assets at 3.3% yoy. But investment has risen at just 1.5% a year. So consequently, the ratio of investment to cash has slumped from an average of two-thirds since the 1980s to just 40% now.
It does seem that there has been build-up of cash relative to short-term debt, particularly in the credit boom of 2000s. This suggests that corporations were borrowing more then and needed to increase their cash buffers as a safety measure.
So companies are not really ‘awash with cash’ any more than they were 30 years ago. What has happened is that US corporations have used more and more of their profits to invest in financial assets rather than in productive investment. Their cash ratios are pretty much unchanged, suggesting that there is not a ‘wall of money’ out there waiting to be invested in the real economy.