Companies' cash piles

Show us the money

For the recovery to proceed smoothly, firms must stop hoarding cash

IF THE private sector continues to save hard even as governments try to borrow less, the risks of a double-dip recession rise. A long period of high household saving seems assured in rich countries whose consumers lived off credit and have heavy debt burdens to show for it. But much of the recent increase in private-sector savings comes not from consumers but from businesses. Profits have been more than enough to cover corporate spending in many parts of the rich world, leaving an excess of funds for firms to squirrel away. A lot depends on whether this continues.

If cautious firms pile up more savings, the prospects for recovery are poor. Economies will be stuck in the current—and odd—configuration where corporate surpluses fund government deficits. If firms loosen their purse-strings to hire workers and to invest, that will allow governments to scale back their borrowing.

The degree of corporate saving varies from country to country. British businesses are among the biggest savers. Last year they produced a net financial surplus of 8% of GDP—most of it by non-bank firms (see chart 1). That surplus went a long way to offsetting the government’s 11% deficit; a 1% current-account deficit and a 2% household-sector surplus did the rest.

Firms in America have been saving, too, even if they have not been quite as thrifty as British ones. The Federal Reserve’s measure of the “financing gap”, the shortfall of corporate income relative to spending, was minus 0.8% of GDP (ie, a surplus) last year, though the gap closed in the first quarter of 2010. The surplus is bigger if the retained earnings of foreign subsidiaries are included, as they are in European measures.

The corporate-saving rate has also increased sharply in the euro zone: a deficit of 4% of GDP in 2008 had all but gone by 2009 (see chart 2). That change came largely from big cuts in spending by firms in France and Spain. German firms have been running cash surpluses since 2004, when profits began to rise as a share of national income as real wages stagnated.

On the face of it firms are in a position to spend more and aid the recovery. After all, businesses are supposed to be repositories for saving, not a source of it. Optimists point to the record $1.6 trillion that American firms have on deposit, in money-market funds, and in bonds and bills. With interest rates so low, this cash might be put to work more profitably. Firms may well have cut their spending too much in the rush to conserve cash during the darkest period of the crisis. Consumer spending has turned out to be stronger than had been feared, says David Bowers of Absolute Strategy Research. “Capital spending, inventories and jobs are too low given the level of consumption,” he argues.

Even so businesses may not feel it is safe to splash out on new machines, stocks and employees. America’s corporate cash pile looks less impressive when set against its debts. Firms need to keep more cash in the kitty if they have large debts because these are raised and repaid in lumps, says Andrew Smithers of Smithers & Co, a research firm. America’s non-bank companies held liquid assets worth around 23% of debt in the first quarter—a bit higher than the average of the past 40 years but still below the levels in 2006.

Many corporate treasurers will want to hold more cash than normal given the size of their firms’ debt and the frailties of the financial system. Before recession struck firms in America and Britain had not needed to borrow much, if at all, to finance new offices, factories and plant. But their debts increased all the same. American companies used debt to buy back their own shares; British businesses used it to purchase stakes in foreign firms. High debt is a legacy of those deals and makes firms nervous about running down cash or spending more of their profits. It will take time for businesses to be confident that banks will be there should they run short of cash.

Corporate spending is dogged by other uncertainties. Few rich-world businesses can feel confident about expanding capacity when the outlook for consumer spending is so cloudy. Fiscal stimulus has helped shore up aggregate demand. Now the worry is that corporate taxes may rise as governments try to fill the hole in their finances, and that non-bank firms will get caught up in a regulatory backlash. Businesses seem short of ideas about how to grow. Technology is not the must-have item it was during the last big investment boom in the late 1990s.

So firms may well want to sit on their existing cash piles. But the case for generating further surpluses seems less compelling. Business investment is as low as it has ever been as a share of GDP (see chart 3). Firms run the risk that their stock of capital is too depleted to meet even sluggish growth in demand. The likeliest outcome is a hesitant recovery in business spending as firms balance the risks of inadequate investment and insufficient cash. If banks continue to be a blockage, firms may look for a way around them. This week Siemens, a big German engineering firm, said it would apply for a banking licence so that it can use its cash reserves to lend to customers. Fine, but for the sake of the economy, better a borrower than a lender be.