Wednesday, June 29, 2011

Corporate Cash

It is, by know, well known that corporations have greatly enlarged cash & cash equivalents accounts. I first noticed the trend a couple of years ago, looking at Microsoft's balance sheet for 2009. In fact, I turned up some research that indicated cash balances were rising, not to the degree they are now, during the 2000s because of increases in operating risk. Operating risk is the uncertainty of one's operating cash flows, where the uncertainty can be generated on the revenue side, or the expenditure side.

Having done some of my own legwork on the recent buildup of liquid assets, I found that the primary cause is the sharp decrease in capital expenditure. Capital expenditure is the purchase of long-term assets used to carry on the business of the firm. For example, if a brewery adds or replaces a kiln, or a conveyor belt for the filling process, that's capital expenditure. So the question isn't, why do firms have all this money, the question is: why aren't firms investing?

Several reasons have been advanced for this. The pop-Keynesian story is that Aggregate Demand collapsed and hasn't recovered. Of course, that papers over the fact that personal consumption, both in real and nominal terms, has fully recovered and then some. The part of AD that hasn't recovered is corporate investment. So, AD collapsed because a component of AD collapsed? Lest I be thought to be begging the question, I will say that the story is that firms aren't investing because they are worried about future demand. For this story to have legs, firms must be more worried than normal about future demand, because I don't know of a company that isn't always interested in maintaining/growing revenue.

The other reason is that firms face a climate of greater uncertainty regarding the government's actions. This is called "regime uncertainty." It is caused by the government passing legislation that is difficult to interpret, will probably raise costs, and changes the regulatory game. The current federal government passed two such bills, the health care reform bill, and the financial services reform bill. Both of these are monsters (2000+ pages each), and both have significant consequences for the future that we are just barely beginning to understand. For example, Dodd-Frank is going to kill access to capital for small and mid-sized firms, thus further tilting the field in favor of the big boys that don't rely on bank financing, and in fact can go to other countries for financing.

I find the regime uncertainty story personally more compelling, because if one looks are recessions, the longest ones are associated with the most government interference. I know, the causation may be going the other way (i.e. government only interferes with really bad recessions, therefore there is an underlying factor causing recessions to be long and government interference) but I don't find that to be a convincing story.

In the next post, I will address those individuals who are suggesting that the corporations should put their money to work in order to speed recovery.

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