It remains one of the enduring mysteries at the root of Canada’s spotty economic performance since the Great Recession.
Why, if Canadian companies are cash-rich, are they so reluctant to spend?
The problem deeply troubled former Bank of Canada governor Mark Carney. He called these cash hoards “dead money,” often badgering corporate Canada to spend it or return it to shareholders.
A recent report from the International Monetary Fund helps solve at least part of the cash hoarding enigma.
Left alone, companies will soon start spending all the money they’ve been stashing away for the past decade. It might even be a prelude to a capital expenditure boom, according to the IMF report – Is Dead Money Alive?
Canadian companies aren’t unique in hoarding cash. But companies here have been doing more of it than businesses in other leading developed countries. Since the mid-2000s, the cash holdings of non-financial corporations have increased faster in Canada than anywhere else in the Group of Seven.
“While the increase in cash holdings by non-financial corporations took place in several advanced economies, the increase in Canada has been much stronger,” the report concluded. “This may reflect cross-country differences in the industry mix, as some industries tend to hold greater cash positions given their characteristics.”
Canadian companies have gone from being net borrowers to net lenders.
By the end of 2013, non-financial companies had $626-billion of cash on hand, up from $591-billion in the third quarter of 2012, according to Statistics Canada.
But who is hoarding, and why? The IMF report, based on a detailed look at the behaviour of public companies in Canada, shows that energy and mining companies account for the lion’s share of hoarding – roughly 60 per cent in 2012. Since 2005, energy and mining companies have doubled their cash holdings.
The same is not true of manufacturers, who showed a decline in cash holdings over the same period.
The cash in the hands of Canadian companies represents 30 per cent of gross domestic product. That compares with a G7 average of 25 per cent.
Energy and mining companies need more cash because their businesses depend on large infrastructure investments, such as those in Alberta’s oil sands. And Canada has more of these kinds of companies than other G7 countries.
The other piece of the puzzle is why companies choose to hold cash, rather than, say, raise their dividends, hire people, invest in new plants, make acquisitions or do more research and development.
The IMF concluded that the answer lies in a “precautionary demand for cash in an increasingly uncertain economic environment.”
There is a “positive and significant relationship” between cash holdings and companies exposed to boom-bust cycles, the report found.
So energy and mining companies, which are at the mercy of large and unpredictable commodity price swings, tend to load up on cash when the value of oil or gold soars. And that was the case through the 2000s.
Rising profits and lower tax rates also contributed to the cash build up, the IMF said.
Throw in the shock of the Great Recession, which caused resource companies to become hyper-cautious, and you have the main answer to the cash hoarding mystery. “Greater macroeconomic uncertainty may have induced firms to raise the cash buffer at their disposal,” according to the IMF.
Going forward, companies are poised to spend more aggressively if the economic models are correct. But the splurge is likely to bypass manufacturers, who have not amassed the same stores of cash.