Dead money

There are good reasons for hoarding cash.

deadmoney 665Outgoing Bank of Canada governor Mark Carney famously chided corporate Canada this summer for sitting on mountains of “dead money,” the idle dollars on balance sheets that could instead feed economic growth. Lots of executives take issue with that criticism. Bombardier, Canada’s pre-eminent industrial manufacturer, for example, wants Carney to know that all its cash holdings are, in fact, alive and well, and being pressed into service to develop the aerospace giant’s newest line of jets.

“We’re investing,” insists Shirley Chenier, senior director of investor relations. In the past year, she notes, Bombardier allocated $1.3 billion to capital expenditures for expanded manufacturing facilities. At the same time, the company has squirrelled away over $3 billion in its rainy-day account. “We realize it’s at a high level,” Chenier acknowledges. “We want to be prudent.”

Who could argue with that kind of logic? Yet Carney, the governor-designate of the Bank of England, in widely quoted August remarks to the Canadian Autoworkers, insisted companies should put their cash holdings into circulation, either by investing it or giving those funds back to their shareholders in the form of dividends. To him, those pools of cash represent an untapped—and possibly last-ditch—source of stimulus in a difficult economic environment where more public spending is politically untenable and lowering interest rates is financially unwise. That viewpoint seems to have followed him to the U.K., where a Guardian columnist in January urged policy-makers to heed Carney’s advice and force British firms to relinquish their own hoarded pounds.

The running tally of “dead money” in Canada? About $600 billion, or a bracing 32% of Canada’s GDP, according to an estimate quoted in January by RBC Global Asset Management chief economist Eric Lascelles. To put that big number into context, he noted that U.S. cash reserves account for just 9% of the domestic economy. Yet even the U.S. figures are staggeringly large. S&P 500 corporations had about $900 billion in surplus cash socked away as of mid-2012, 40% more than just prior to the credit crisis, says The Economist. What’s more, the growth of all this non-circulating cash is a long-term trend that predates the recession and transcends national borders, according to studies done by the IMF and the World Bank.

The question is whether those billions in unspent corporate cash represent an insidious problem or just common sense.deadmoney graphic

Economics, like politics, can make odd bedfellows. The steadily bubbling dead-money controversy has created a counterintuitive alliance between Carney, labour economists like the CAW’s Jim Stanford and left-leaning equality activists. In the other corner sit mainstream business economists, who argue that Carney, in a rare occurrence, missed the point. As Lascelles commented in The Globe and Mail, “It is far from clear that firms are holding more cash than they should.”

The plain-spoken Carney, no fan of central banker bafflegab, leaves little doubt as to his view: “Cash holdings relative to assets have doubled over the course of the last decade,” he said in a press conference in August. “Doubled. So, at some point—companies will make these judgments, shareholders would make those judgments, managements will make these judgments—those cash balances could become excessive.” But, he added, “I’m not dictating to companies what they need to do.”

Of course, that was exactly what it sounded like he was doing. But the effectiveness of his rhetorical stimulus is less clear. “It’s kind of like being stuck in a traffic jam and honking your horn at the guy in front of you,” says Canada West Foundation senior economist Michael Holden. “It might make you feel good, but it won’t get the traffic moving.”

Not surprisingly, Carney got the details of the situation correct. According to the Bank, corporate Canada’s overall debt-to-equity ratio—under 0.9, down from 1.5 in the mid-1990s—is at a historic low, the result of two decades of private-sector deleveraging. What’s more, with rock-bottom interest rates and a robust banking sector, Canadian firms have no reason to fret about not being able to access affordable capital when they need it to grow their operations. Finally, the bank’s own surveys reveal that business confidence in Canada remains relatively upbeat, despite the persistent uncertainty in the U.S., Europe and China. Those indicators strongly suggest that Canadian firms don’t need to be stuffing so much cash under the corporate mattress, because they have access to plenty of credit if they need it.

So why all the caution?

The bank sees it as unneccesary and views the cash stockpiles as the only available lever to goose the economy. Canada’s debt-saddled governments aren’t in a position to reprise the 2009 stimulus spend, and Canadian consumers definitely shouldn’t be further stressing their credit cards and bank lines. Yet on an aggregate level, business fixed investment hasn’t been pulling its weight, contributing 1.4% to annual real GDP growth in 2011, but only 0.5% in 2012, according to a recent Bank of Canada report.

deadmoney graphic 02Lots of economists don’t buy Carney’s diagnosis. “There’s nothing peculiar about the fact that companies are holding that much cash on their balance sheets,” says William Robson, president of the CD Howe Institute, who feels that this issue has been overblown. “The Bank of Canada has lots of research to show that it’s not dead money.”

Canadian firms that operate in a highly globalized and somewhat fragile environment, say Carney’s critics, can hardly be blamed for exercising caution. After all, crude oil and commodities prices are still so low that plunging resource revenues forced Ottawa to defer its target date for balancing the budget. And while the U.S. housing market seems to be showing a pulse after four horrendous years, the European Union sovereign debt crisis continues to steamroller along, with countries like Spain facing Depression-era unemployment rates.

What’s more, circumstances vary sharply across sectors, undermining sweeping solutions. For example, Canadian banks with U.S. subsidiaries have had to increase their liquidity to comply with new regulations. And in energy, high prices for synthetic crude and liquid natural gas mean producers are generating a lot of extra cash.

Laurence Booth, a finance expert at the University of Toronto’s Rotman School of Management, adds that the Canadian economy still has excess capacity, although recent bank data shows there’s not much slack left. (The October 2012 Monetary Policy Report projected 2.3% growth for 2013, with the economy reaching full capacity by midsummer.) “Whether or not [companies] should be spending their money building factories is highly debatable,” he says. “They’ll start investing when they think there’s demand out there to warrant expansion.”

Resource giants like Suncor, with $5.1 billion in cash on its books, echo the point. “In an uncertain economic environment with volatile commodities pricing, we think it’s prudent to have cash on our balance sheet,” says spokesperson Sneh Seetal, adding that the oil giant budgeted $6.65 billion in capital spending for 2012 ,while also returning $1.75 billion to its shareholders during the year via increased dividend payments and the repurchase of shares.

Suncor’s generosity toward its investors may be laudable, but Booth points out that the overall picture is murkier where it comes to dividends. Historically, he says, about 40% to 50% of surplus cash—which is, by definition, pure profit—finds its way back to shareholders. But in recent years, Canadian firms have preferred to hold on to more of these surpluses, with the result that the proportion returned to investors overall is more like 35%. “They’re not paying out as much in dividends,” Booth says.

In fact, observes CAW economist Jim Stanford, the apparent cash-hoarding habit Carney identified is not merely an artifact of the post-2008 economic uncertainty in Canada, but rather a “long-term secular trend” in many industrialized nations. And it seems to have become more pronounced over time.

Analysts with both the International Monetary Fund (IMF) and the Organization for Economic Co-operation and Development (OECD) were scratching their heads over these issues well before the 2008 credit meltdown. The IMF, in a 2006 study, noted that non-financial corporations in the G7 had gone from aggressive borrowing in the mid-1980s to conspicuous saving in the mid-2000s, and described the trend as “an unusual phenomenon.” “This behaviour has been widespread, taking place in economies that have experienced strong economic growth (Canada, the United Kingdom and the United States) and in those where growth has been relatively weak (Europe and, until recently, Japan),” the report observed. “Simply put, firms have been investing a smaller share of their profits in upgrading and expanding their capital stock.”

Both organizations cite various theories for the accumulation of surplus cash—everything from the relentless downward pressure on wages, and the resulting drop in payroll expenses, to stepped-up expectations of institutional investors and management-led hedges against exposure to long-term pension obligations. There are even more abstruse explanations, for example, that computer equipment accounts for a growing portion of capital investment but has become less expensive over time, meaning fewer dollars spent. But no one’s really sure.

What’s not in doubt is that the business sector is spending less and less on machinery, manufacturing facilities and R&D. The OECD, in a 2007 economic outlook assessment, singled out the U.S. as having an especially sluggish rate of business investment, even several years into the post-dot-com-bust recovery. North of the 49th, Stanford cites even longer-range data showing that “net capital formation”—i.e., investment in these sorts of real assets—fell in Canada from almost 16% of GDP in the early 1970s to about 6% by the mid-2000s.

There’s also a chicken-and-egg problem at the heart of this dynamic. As the business sector accumulates more surplus cash, it has the effect of driving down interest rates because there’s less demand for corporate bonds and other forms of business lending. But low interest rates, at least in Canada, have pushed household debt to such vertiginous levels that officials like Carney know they shouldn’t be counting on consumer spending to drive the recovery—ergo, the call for more corporate investment.

When IMF analysts pondered the problem, the agency wondered whether the build-up in excess cash would be a passing phase. “A key question in trying to understand corporate behaviour is whether this decline in investment spending is simply a short-term reaction to the high corporate debt levels of the early 2000s.”

As far as Stanford is concerned, that debate appears to be settled. He calls for policy changes, such as dialling back corporate tax cuts that have not spurred new investment, as policy-makers had promised. “There hasn’t been much bang for that buck,” he says, noting that Canadian firms have generated $745 billion in after-tax cash flow since 2001. “If companies aren’t going to spend, the government could do more for economic growth [by] spending that money on infrastructure.”

Problem is, the extended build-up of corporate cash has occurred in both high- and low-tax jurisdictions, which is yet another reason why some economic analysts are both confounded and handcuffed.

But not all: William Robson says that policy-makers need to demonstrate more faith in the business cycle. Liquidity, as he says, “causes good things to happen.”

In fact, this may be one of those fortuitous situations in which both sides turn out to be right. Having read the riot act to the corporate elite, our superstar central banker can depart for London, secure in the knowledge that Canadian companies will eventually have little choice but to start spending all that accumulated cash. And when that happens, no one will much care whether it was Mark Carney’s provocations, or just the ebb and flow of the business cycle, that brought those allegedly dead dollars back to life.