With the global economy spluttering and employment growth still stagnating, the supposedly high cash levels accumulating on US corporate balance sheets are drawing heightened attention – and plenty of criticism.
Politicians would prefer that US corporations deploy their cash to help thin the ranks of the unemployed. Investors, too, are uneasy – many have accused the business community of lacking "animal spirit" and have demanded that corporations reinvest their cash in projects that earn a higher return, buy back their shares or return the capital in the form of dividends.
Most press coverage attributes high cash balances to corporate anxiety about access to credit. The Wall Street Journal recently reported: "Corporations have a higher share of cash on their balance sheets than at any time in nearly half a century as businesses build up buffers rather than invest in new plants or hiring."
The usual discussion of the corporate cash mountain compares growth on a year-over-year basis. According to the Federal Reserve’s Flow of Funds Guide published in mid-September, at the end of the second quarter of 2011 US non-financial corporations held liquid assets of $2,047bn, 24.37% more than the previous year. At a time of negative real interest rates, this rate of cash accumulation certainly seems alarming.
But is it really? The answer, it turns out, is probably not. (see chart)
In fact, most of the alarm about excess cash accumulation seems to result from how the Bureau of Economic Analysis and the Federal Reserve report their data – both organisations publish numbers only in press releases going back to 2008. To analyse a longer sweep of history, analysts and commentators would need to dig deep into both organisations’ websites, and it seems that few do.
Instead, they have anchored to year-end 2008 data as the basis of comparison – a period when cash balances were artificially low.
At the time, with short-term credit markets seizing up and US corporations suffering the worst economic quarter since the Great Depression, many businesses dramatically drew down cash balances in an effort to maintain their operations.
Even just slightly more complete Federal Reserve Board data tell a different story. As shown in the table, growth in liquid assets from the 2008 low to the second quarter of 2011 was 46.33%. But growth in liquid assets since 2007 was a more palatable 34.08%.
On a compound annual growth rate basis, the results diverge even more – growth in corporate cash since 2008 was 16.45%, compared with a more modest 8.74% since 2007. Comparing current liquid assets with the 2008 trough clearly leads to a skewed result.
For a more accurate picture of corporate cash balances, it is perhaps more reasonable – and revealing – to use corporate profits as a basis of comparison.
After all, profits are the major source of cash accumulation for non-financial businesses.
So if cash balances are growing faster than profits, would that not be a strong indication that corporations are in fact sitting on their cash? More on that analysis in the second article next month.