Missing Ingredient

Regarding the American corporate sector today, here's the question: why is there so much balance sheet inefficiency, that is, why are corporate cash balances large and growing?

Being liquid (that is, having cash that is available immediately) facilitates executing a particular investment or retiring maturing debt, and is thus often a corporate objective. Corporations generate cash through profitable operations, and/or they borrow it through, for example, the issuance of bonds. They have been doing both in recent years; corporate profits as a percent of GDP are at an historic high, and bond issuance has been robust, given that the cost of such capital is at the lowest level in more than half a century - as shown in the chart below, bond yields are just above 5 per cent, a rate not seen since the mid-1960's.

But US corporate cash balances have in recent years been well beyond the levels needed to implement a timely investment strategy, be it of a physical nature (buying equipment and building factories and hiring workers) , a share re-purchase or dividend program, or an acquisition or merger. Corporations have been buying back their own shares and in many cases increasing dividends. But for the most part, they have been hoarding, especially in accounts abroad. Cash on the balance sheets of US non-financial companies now stands at $1.48 trillion, up 10 per cent from a year earlier and some 81 per cent from 2006. The opposite side of this same coin is that the current private sector investment cycle is one of the weakest in decades. Non-defense capital goods orders (excluding aircraft) have increased by a mere 0.3 per cent per month, less than half the rate of business investment between 1993 and 1998, a difference that is even more dramatic when one considers that corporate bond yields averaged about 8 per cent in the 1990's.

So why this dearth of investment when cash is so abundant and cheap? Weak aggregate demand is partly to blame - unemployment, though falling slowly, remains high (particularly when underemployed and discouraged workers are added to the registered unemployed). But this is a chicken and egg argument, because unemployment is high in part because of weak investment. More importantly, corporate America has zero clarity regarding U.S. fiscal policy, particularly tax rates, and has come to believe that political brinkmanship and deadlock will persist in Congress, especially given that effective Congressional compromise, and Presidential leadership, have all but disappeared. A new study from the Peterson Institute finds that some 900,000 jobs have gone missing since 2009 because of "crisis-driven fiscal policy".  Seems the quantitative impact of Washington ineptitude, through its effect on business investment, is bigger than anyone thought. And it's not helpful that America's President clearly misunderstands - even disdains - business.

The fiscal drama is to continue, with new budget and debt-ceiling deadlines set for January and February next year. Corporations will remain flush with cash, but will likely still restrain their investment activities given that a necessary ingredient - confidence - has not yet returned.