... the trend toward corporations holding more in cash very much predates the Great Recession; indeed, it was already apparent back in the 1990s. Thus, along with thinking about why events of the last few years have led corporations to hold more cash, we should be thinking about influences over the last couple of decades.The Conversable Economist
Why are U.S, Firms Holding $5 Trillion in Cash?
Tim Taylor | Managing editor, Journal of Economic Perspectives
25 comments:
Besides a "precautionary motive" and a "repatriation motive" for holding cash or safe, low-yield, cash-like securities, isn't there also a "nothing better to do with it" motive? If a firm decides it can make investments with its cash that are more valuable than its cash, it will probably make them. But when it decides there are no such investments available, it will hold the cash.
A lot of economists seem to have a pie-in-the-sky, "build it and they will come" philosophy about business investment. And so they are mystified about why investment doesn't occur. But business people don't just dream fantasies, and then throw money at them. Their customary practice is to take the temperature of actual or potential customers to discern the presence of demand. In fact, most of the ideas come from the customers themselves, and are not originated by the business. The customers signal a want and a readiness to pay, and that gives the business the confidence to invest.
And it's not just some kind of crazy guessing game. Business people are in constant communication with their customers, all the time. If the business's perception, based on these frequent conversations, is that their customers are tapped out, then they will stand pat, or at best engage in the zero-sum market share battle.
Economists have to stop reading hagiographies of rare, bold visionaries like Steve Jobs, and talk to more normal business people about normal business practice.
I observed that this trend really got rolling in the wake of the 9/11 terrorist attacks..... And still persists.
This could be thought of as 'corporate savings', where I like Bill Mitchell's definition of savings as 'a hedge against uncertainty over time'.
Seems like many non-FIRE businesses develop a strategic management culture that like to have a lot of savings perhaps to be able to make it thru a future tumultuous period, similar to many households who have enough income to be able to save... (With the idiots we have running policy perhaps I can't blame them)
Rsp
Risk off v. risk on. Liquidity preference is a signal of taking risk off.
Well, maybe that's how it works in the financial sector. But my risk aversion is a supply side phenomenon, and the problem from where I sit is a demand side problem. Business people are as hungry for opportunity as ever, but there just aren't many opportunities, because there aren't enough customers with enough disposable income to turn their desires into actual market demand. When incomes are on an upward trajectory there is a virtuous cycle: increasing demand for goods and services, increased business investment, increased employment, increased incomes, increased demand, etc. When incomes stagnate, businesses stop investing - not because they are phobic and the confidence fairies have left them, but because they are by and large rational.
Dan, if you look at the data this is not a recent phenomenon resulting from the crisis, as most suppose, including Taylor until he examined the data. That's his point. So it is not just the contraction due to the crisis.
My suspicion is that lack of investment opportunity due to fall in profit rate for a broad range of firms. Holding funds off shore to avoid taxation is another, i.e.,a tax shelter.
I would seem that If demand were roaring, things would be different. But part of this period seems to have been a boom time. That's a bit puzzling.
I didn't say it was from the crisis, Tom. Middle class and working class income stagnation has been going on for quite some time, pre-crisis. The greater the percentage of a firm's revenues that are returned to ownership, and the less that is cycled back through the consumer sector by being returned to workers, the less demand there is and the less opportunity there is for investment in new consumer products.
American capitalism is a sick gluttonous vampire surrounded by emaciated cadavers. Once the working/consuming class is sucked dry, there is nothing left for the capitalists to invest in.
Business profits are high. That's not the problem. Businesses don't invest because their profits are a "hot potato" that they feel compelled to get rid of. They invest because there is an opportunity to turn those profits into more profits. They've killed the golden consumer goose, and now all they have left is their money.
Here are corporate profits. Run it from 1990 to today. Through the roof.
http://research.stlouisfed.org/fred2/graph/?id=CP
Profits are up thanks largely to the surge in the govt deficit.
Mature businesses all observed that people were spending more than their income and tried not to get caught with too much excess inventory (redundant?) when the bubble burst.
Who wants to risk capital for a chance for an iPad or pet rock fad? The teeming masses are back to "need" based consumption rather than "want" based instant gratification.
Profits, if retained, remove funds from the stock held by consumers.
The stock held by consumers gets smaller, reducing the opportunity for profit over the next go - round.
Rinse and repeat until flow stops completely. The only source that can overcome this pattern of decay (sustainably) is net government spending. The system can be amplified through the credit circuit but amplification has limits.
We talk all the time about how economics is about flows and that's true. What is left unsaid is just as important.
In order for there to be flows there must be stocks. There must be at least one stock for flow to be possible.
Rinse and repeat until flow stops completely. The only source that can overcome this pattern of decay (sustainably) is net government spending. The system can be amplified through the credit circuit but amplification has limits.
It's true that income was stagnant but consumption was being sustained by increasing debt. During the boom years when consumers were debt financing through plastic and HELOC's, businesses were still increasing savings instead of investing.
I really doubt that many astute business owners foresaw the unsustainability of the process and stayed on the sidelines. Sharp ones were taking advantage of of the boom and increasing sales.
So I agree with Tim Taylor that there are unanswered questions here.
The question is not about profits being up, which is explainable in terms of deficit size and profit share/labor share, but rather why profits are being saved instead of reinvested. Obviously in a contraction there is little incentive to invest with low demand, but why was the saving/investment ratio tilted toward saving when the economy was expanding?
I agree with Dan K's take. Also note that there seems to be another wave of share buybacks underway...
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"why was the saving/investment ratio tilted toward saving when the economy was expanding?" [Tom]
Here is the chain of causation:
use of cheaper labor overseas => higher profits and lower domestic labor income. Higher proportion of income to capitalists => more saving. Less domestic consumption => less domestic investment.
The economy was expanding more for the savers (owners of capital) than for the mass of workers / consumers...
DD, but a significant portion of the savings seems to be in overseas accounts that are not being repatriated due to taxes and not invested abroad either.
The big problem here is that holding retained earnings is inefficient. Firms know that this reduces competitiveness. There has to be a very good reason(s) for holding funds idle. It is like leaving capital goods idle. Well-managed firms don't do this without good reason. Either US management is deteriorating or something is up.
It's true that income was stagnant but consumption was being sustained by increasing debt
Sustained by increasing debt is an oxymoron. Debt can only temporarily boost demand...the amplifier must be leveraged with real money. And there is a limit, say 10 or 20 to 1....that's about as far as it is possible to stretch (leverage) debt.
It's also irrational to say that retained earnings is inefficient in the sense that businesses have little control over it.
If businesses were to invest all of their profits back into production there wouldn't be enough purchasing power to buy the additional production. It's like hiring more workers than you need.
This would require much bigger deficits and productive capacity would easily outstrip demand anyway.
No one needs 10 TV sets or 10 cars or for that matter 10 anythings,
It is pretty much impossible to reinvest all profit in the aggregate. The math just doesn't work.
paul, the way it is supposed to work is that business reinvests profits after setting aside a reserve against uncertainty for liquidity, but most businesses rely on a line of credit for cash flow needs. What is not reinvested is supposed to be distributed to owners as dividends. Leaving more than enough cash on the books to meet anticipated (reasonable) needs is inefficient. This is definitely an aberration in normal practice.
This is definitely an aberration in normal practice.
Tom, I don't think it's been an aberration over the last 20 years or so.
Maybe it's due to the emergence of vulture capitalism I don't know. Companies may feel the need to protect themselves from other companies.
Even if excess profit were paid out in distributions that particular kind of saving still accumulates at the top end of town. There's only so much a person can spend, so those funds go to waste.
Practically speaking savings per se is inefficient, but I believe that is ingrained in human nature. We just have to deal with it.
I think the best we can do is create a system where all groups gain at the same rate. Inequality is destroying us from the inside out.
And maybe that's what you were getting at. Seems like the system was much more equitable and stable when we had very high taxation at the top end.
Things have really gone south since we bought into the idea that letting rich people keep more if their money would make the rest of us better off.
Fact is, paul, that is not the business of business to save. Households save. When business does, it creates questions.
it creates questions.
No disagreement there. The big question is what do we do to change it?
I advocate for higher taxes. Others think we should eliminate corporate taxes altogether. That's a pretty wide bracket.
Why shouldn't businesses save, just like households? And why is it a problem? Is it a problem or a symptom?
It's a symptom of a possible problem when firms increase savings in aggregate, i.e., save rather than invest/distribute as significant trend. It runs against management principles wrt optimization of resource use. The usual explanations are "expectations" or "uncertainty," but those don't constitute causal explanation involving variables, so it's just waffling.
Thanks Tom...
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