WSJ: Corporate Cash Hordes Might Mean Capitalism Is Fresh Out of Ideas

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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