In March 2012, The Economist reported that UK corporate surpluses reached more than £700 billion last year, amounting to almost 6% of GDP. The United States told a similar story with the 1,100 non-financial corporations rated by Moody’s showing cash balances of over £1.24 trillion (almost 10% of US GDP)… and in Europe, a group of 30 larger cap non-financial corporations (as at June 2011) were sat on over $872 billion (around 7.2% of European Union GDP).
There are a constellation of reasons why firms are hoarding their cash, but a few key ones are:
- Economic Sentiment:
There is no doubt that firms of all sizes are viewing the economy as being very uncertain and potentially precarious. With such sentiment being widespread, firms are much less likely to invest in assets (which may decrease in value) or projects (which may fall victim to economic volatility). The poor perceived outlook on consumer, corporate and institutional spending (across most global territories) also makes firms considerably less likely to engage in expansion strategies.
- Tax & Policy:
Entrepreneurs and CEO’s are genuinely worried that firms are going to face years of increased taxation to pay for the unprecedented economic stimulus. Alongside this one must also factor in the ‘risk value‘ of cash. Businesses operating in a riskier environment will inevitably want a higher return on the capital they deploy. In most developed countries however, the marginal increases in taxation have yielded a disproportionate ‘flight to safety‘ where firms end up hoarding their cash balances against forced redistribution. A less discussed but equally significant phenomenon has been a gradual erosion of faith in central governments and their policies. A well functioning economy requires that entrepreneurs, firms and other stakeholders place trust in their political leadership to not only support them- but be consistent in their approach. One business advisor I spoke to said he finds it very hard now to fathom, “what on earth they [referring to government] will do next…“.
- A Lack of Investment Alternatives:
Private sector cash balances are not a new phenomenon within the economy. The new aspect is behaviour. These cash balances were often plugged into a wide variety of financial instruments (such as equities, funds and more) which typically gave near cash-like risk profiles with a reasonable return. Such instruments are now lacking as even previously robust classes such as sovereign debt and large cap equities now carry more risk than most corporate treasury managers would like to hold without a corresponding return.
- Hidden Deficits:
The profligate spending of the past 25 years has also left a tremendous amount of firms worried about structural deficits which may be created through gaps in pension fund obligations and even gaps in the value of hard assets. Many larger firms in particular are holding cash-balances on reserve to cope with these eventualities which could easily prove fatal otherwise. To put this in perspective, the US Private Sector is estimated to be running a pension deficit of over $420 billion.
What’s the Problem?
Instead of looking at hoarded cash as being a ‘rainy day fund‘ we need to view these balances as stores of economic growth. This cash represents potential investments, new jobs, new innovations and the potential for significant wealth creation and diffusion. So how can we get firms spending again?
- Quantitative Easing… but not as you know it…
‘QE‘ worked to the extent that it cleansed the balance sheets of many financial institutions and did, to a degree, push cash into the equity markets. The problem is that quantitative easing injected cash to buy high quality assets (gilts and corporate paper). In reality, the institutions who now hold the fresh cash are often unwilling to take risky debt onto the balance sheets meaning that at the coal-face firms may not be getting the benefit. Governments have a unique ability to aggregate and de-risk. Using a bank of recovery model the government and banks could aggregate their risks into a lending pool which directly funds the businesses who need the cash the most.
- Incentivise things that aren’t cash…
Rather than lowering the value of cash (and thereby hitting savers hard) governments should really apply better incentives for those who want to invest in the constellation of instruments that aren’t cash. Maybe give better tax-breaks for investing in small business, maybe give a lower capital gains rate for certain classes of equity, or maybe give much clearer tax benefits for firms who wish to invest in growth. Governments may even be able to create a shadow lending rate for businesses based on long-term gilts.
- Incentivise Business Activity…
Incentivising business means incentivising entrepreneurship and celebrating wealth creation. Many governments, faced with a popular revolt, have chosen to martyr wealth without realising that it is the source of entrepreneurship, innovation and philanthropy in their economies. Entrepreneurship is at the very heart of any development discussion- principles which we hypocritically apply to emerging economies without applying them to our own.
- Incentivise Hiring….
People are pretty close to being the single most important asset a firm can have. Many businesses I speak to are often reluctant to hire for reasons that may surprise you. In many cases, they simply do not want the additional compliance headaches and in many cases they are scared of litigation should they need to let people go… Our employment law and employment regulations are in drastic need of updating to ensure they not only best represent the interests of the employee and the employer, but also to ensure they streamline and de-risk the hiring process.
- Change the Story…
People sometimes underestimate the role of the media in our economic story. Human beings have a tendency to generate availability heuristics meaning that we give increased importance to things we can recall quickly. When assessing the economy, it is far easier to recall stories of doom and gloom than positivity. It’s time to change the sentiment, and that means changing the story.
The developed world economies have a tremendous amount of positive attributes. We have an extremely skilled labour force, fantastic infrastructure (physical, economic and political) and a very mature capital market.
The world of business is scared without realising that it, itself, is the cure.