From: Rakesh Bhandari (bhandari@BERKELEY.EDU)
Date: Fri Oct 22 2004 - 12:38:03 EDT
WSJ.com - October 22, 2004 THE MACRO INVESTOR By STEVE LIESMAN Corporate Cash Hordes Might Mean Capitalism Is Fresh Out of Ideas Is capitalism running out of ideas? That's the question posed by Patrick Artus, chief economist and head of research at the French investment bank CDC IXIS Capital Markets. Mr. Artus observes something this column has mentioned often: the huge amount of cash on the books of U.S. corporations and the low investment levels relative to profits. But he takes it a step forward, finding it to be a true in Germany, Japan and, recently, in France. "In an increasing number of countries, companies hold substantial amounts of cash which they do not know how to use, apart from, as was shown by the recent example of Microsoft, distributing it to shareholders (via share buybacks or extraordinary dividends). This trend is worrisomeSŁ" Mr. Artus notes in a recent paper. To Mr. Artus, the cash accumulation suggests that companies lack profitable investment ideas. Even more, it suggests that at least in certain industries, there is a lack of competition. This idea, if true, differs substantially from the prevailing wisdom. Most economists are aware of the same data, at least as it concerns the U.S. But they believe that it suggests a wave of investments and hiring are about to hit the economy. "One of the big points is that when people have a lot of cash they tend to spend it," Standard & Poor's chief economist David Wyss told CNBC recently. "This should be good particularly for [merger-and-acquisition] activity going forward." Since S&P is one of the nation's leading credit-rating agencies, it follows closely the amount of cash on corporate books. Right now, it's nearing a record high, Mr. Wyss said, doubling from the recession to about 40% of long-term debt, from 20%. "A lot of that is because profits have been rolling in and companies have been unwilling to make any real investments," Mr. Wyss said. If this is a long-term phenomenon, it is truly troubling. The overriding concern is how growth can be sustained if today's profits aren't being plowed into creating today's investments and tomorrow's jobs. In addition, one part of the source of these profits are companies and shareholders reaping a greater share than normal of recent productivity gains, at the expense of workers. This raises concerns about consumer spending. Mr. Artus looked at profits and investments as a percent of gross domestic product in four of the five biggest economies in the world. What he found is that profits before tax and interest are running fairly strongly. But investment as a percentage of GDP, while rising, comes in at a multiyear low. To be sure, business investment as a percentage of GDP in the U.S. has been rising in recent quarters. It hit a low of 9.74% in the first quarter of 2003. It's now clawed its way back up to 10.28%, an increase of about $143 billion in nominal terms. But remember, this came at a time when Mr. Bush offered accelerated depreciation for investments, so the underlying growth rate -- the one that will prevail after the incentives run out this year -- is uncertain. By way of comparison, during the boom of the 1990s, about 12% of our nation's output came from business investment. Of course, what became clear only later, is that this was an over-investment boom. Too many computers, factories and telecommunications systems were sold and installed, so for at least some of the past several years has been a slow recovery from that hangover. Let's be clear, there is no "right" level for investment in the economy or corporate profits. Any number of factors can influence them, including tax incentives, technology and competition. During the 1990s, the rapid increase in the processing speeds of computers, combined with the rapidly deflating price of computing costs, induced an investment boom. (That, along with a lot of corporate CEOs drinking the New Economy Kool-Aid.) During the early 1980s, there was strong growth in commercial construction, in part spawned by the tax code. Profits will also vary with tax levels, prices and wages. If companies pay their workers more, shareholders get less. And investment levels also help determine profits. But there is a fairly steady relationship between profits and investments. Since 1947, investments have averaged 118% of profits. That is, companies generally invest more than they earn, in hopes of greater profits in the future. From trough to peak, between 1992 and 2001, the ratio ran a much hotter 128%. Over the past year, it's been a lackluster 102%, just about the lowest level since the 1960s. There's a tremendous amount of cyclicality to investment and profit levels. And Mr. Artus is on shaky ground when declaring some sort of cataclysmic capitalist seizure of ideas. But he's right to point out that something is wrong here. Low levels of investment today could presage declining profits and productivity tomorrow. And if profits are high and prices don't fall, then that is a signal of a lack of competition that regulators should explore. That's because high rates of return should attract competition that should drive down prices. Perhaps the low level of investment is a sign of the confidence level of chief executive officers, amid a war and an election that could result in changes, again, to the tax code. The Index of Leading Economic Indicators has fallen for four straight months, a sign of economic weakness that shouldn't be overlooked. There might also be a growing decline in the corporate confidence in computers and computing power to provide productivity and investment returns. Add it all up and capitalism may not have run out of ideas for the long term. But it sure seems to lack a good one right now. If the ideas are out there, executives seem to be lacking in the courage to go after them.
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