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U.S. corporate cash holdings are nearing $1.5-trillion (U.S.); Canada tips the scales at almost $600-billion (Canadian). (Kevin Van Paassen/The Globe and Mail)
U.S. corporate cash holdings are nearing $1.5-trillion (U.S.); Canada tips the scales at almost $600-billion (Canadian). (Kevin Van Paassen/The Globe and Mail)

BUSINESS INVESTMENT

‘Dead money’ will live on Add to ...

There has been much talk about a great and growing hoard of cash mouldering on corporate balance sheets. Everyone has a take on how this “dead money” could best be used, from plumping government coffers, to acquiring capital goods, to paying larger dividends.

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Undeniably, businesses now maintain strikingly large cash balances. U.S. corporate cash holdings are nearing $1.5-trillion (U.S.); Canada tips the scales at almost $600-billion (Canadian). These amount to 9 per cent and 32 per cent of GDP, respectively – eye-watering sums, both. However, it is far from clear that firms are holding more cash than they should, and companies may continue clinging to this cash with a surprisingly firm grip.

What of the idea that companies could become somewhat less tightfisted in 2013 as de-leveraging fades, the economy stabilizes and the trajectory for public policy becomes clearer? This is still a valid argument, and indeed a part of our own economic forecast. However, most of the momentum should come from diminished saving, rather than an outright draw-down on cash.

Arguing against a large wave of cash disbursement, firms simply haven’t deferred that much spending since the financial crisis set in. We calculate that corporate cash holdings (once properly scrubbed of the natural upward tendency linked to economic growth) have risen by only $79-billion (U.S.) in the United States, and have actually shrunk in Canada. Mercifully, low capacity utilization levels demonstrate that there isn’t a screaming shortage of factories or equipment waiting to be built, anyhow.

What of the longer-lived (and far larger) cash holdings that predate the financial crisis? The very fact that these funds have already persisted across a full economic cycle hints that they aren’t simply waiting for a break in the clouds.

Firms clearly require a certain minimum of cash just to make payroll and to ward off nasty surprises. Households are regularly admonished to maintain liquid savings equivalent to no less than three months of expenses. Canadian firms have roughly managed this; American firms scrape by on barely a month’s costs.

Cash holdings have now outpaced economic growth for several decades. While some view this as evidence of an imminent and long-overdue reversal, others quite rightly argue that a structural change must be afoot for this trend to have endured for so long. Corporations derive no satisfaction from lording over piles of cash that generate negative real returns. We posit several reasons why cash holdings have managed to defy gravity.

First, in an era when corporate leaders now understand that their mandate is not simply to maximize profits but also to maximize survivability, the safety and liquidity of cash is king.

Second, corporate leaders remain reluctant to fully deploy their profits for fear that profit margins and the share of GDP commanded by corporate profits will eventually revert to more historically normal levels, rendering them over-committed.

Third, the cost of capital goods has declined materially over the past 20 years, allowing firms to secure their necessary allotment of plants, machinery and equipment for less money. The resultant savings have flowed into financial assets such as cash.

Fourth, yawning corporate pension deficits may be motivating a precautionary accumulation of cash.

Fifth, certain sectors appear to necessitate especially (and increasingly) pronounced cash holdings. In the American tech sector, firms need the financial means and flexibility to repeatedly develop “game-changing” products, pivot quickly into new businesses, acquire patent portfolios and credibly discourage others from penetrating their core markets. Furthermore, as intellectual property grows in importance, companies feel compelled to pair this intangible and rapidly depreciating asset with cash as a way of stabilizing their balance sheets. Accordingly, a handful of American tech giants now maintain lofty cash levels.

The Canadian resource sector is also cash-intensive. These are businesses whose revenues are mostly outside of their control, gyrating on the whim of volatile commodity markets. Their expenditures are marked by infrequent but massively capital- and labour-intensive projects prone to cost inflation and requiring heaps of ready cash. Resource firms that fail to carry a sufficiently large cash buffer are sternly disciplined by the market, if they aren’t bought (or don’t topple) first.

To conclude, the “great cash hoard” is every bit as great as imagined, but most of it is unlikely to vanish any time soon. The vast majority serves a variety of structural masters. We suspect only a sliver of the U.S. corporate cash hoard will be released as certain cyclical constraints ebb, plumping U.S. GDP growth by between 0.2 to 0.5 percentage points in 2013.

However, Canada’s cash could prove the stickier of the two, despite its relatively larger bulk. Part of this is that Canada’s economic spigot is not set to open as fully as the U.S. Part is that economies such as Canada, Australia, Norway and the U.K. carry a naturally larger cash load than the rest due to their resource-sector orientation.

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