‘Dead money’ may be smart approach, report says

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Canadian companies' sitting on huge cash holdings – "dead money" that should be invested or returned to shareholders, as Bank of Canada Governor Mark Carney put it – actually looks more like a "smart money" approach, says a Royal Bank of Canada analysis.

"There are arguments that can be made in support of firms holding historically elevated levels of liquidity in the current global macroeconomic environment," RBC economist David Onyett-Jeffries says in a research note published Monday.

Frozen capital in the 2008-2009 global financial meltdown restricted access to much-needed funding and so businesses in Canada have tended to err on the side of caution by hanging onto cash, he said.

"Given the persistently high degree of uncertainty about the global economic outlook, it is thus reasonable that firms would opt to hold a relatively larger cash buffer lest they be caught short when the next crisis rears its ugly face," he writes.

Companies also need cash on hand to pay for any pension shortfalls that might occur, in the context of a low interest rate environment and uncertain stock-market returns, he adds.

Finally, businesses are increasingly investing in intangible capital such as patents or R&D, increasing the need for cash since there is no physical asset that may be pledged as collateral, said Mr. Onyett-Jeffries.

Canadian non-financial businesses held $574-billion in cash at the end of the third calendar quarter of 2012, 12 per cent of their total assets, he said.

Canadian companies hold cash equal to about one-third of nominal GDP (32 per cent), roughly four times U.S. levels, he said.

With reduced growth in consumer spending expected, will corporate Canada step up and fill the void by spending more on capital equipment, as Finance Minister Jim Flaherty has urged?

Expect Canadian firms to continue their cautious ways in the near-term and refrain from major spending sprees, says Mr. Onyett-Jeffries.

"As more clarity becomes evident in the economic outlook and external risks subside, Canadian businesses stand ready to take advantage of opportunities as they present themselves and we anticipate that a stronger pace of business investment in structures, machinery and equipment should materialize in the second half of 2013 as firms deploy their ample liquid balances."