Wednesday, January 18, 2017

The Corporate Cash Fantasy

U.S. corporations are “sitting on a lot of cash”. This has been a common refrain for a couple of years now.

What is meant by this is that the balance sheets of corporations are composed of assets and liabilities, and that currently the proportion of those assets held as cash is relatively large.

People view this as a problem because cash isn’t much of an investment. Economic growth comes mostly from productivity improvements, those come from investments, and we’re not investing as much as we could or should. Or so the story goes.

The fantasy is in two parts.

Democrats assert that corporations are holding out until Republicans are voted into power at the national level. Basically, that Republicans are mean.

Republicans assert that corporations are holding cash because they dislike the actual policies of the Democrats, and are holding out until Republicans are voted into power at the national level. Basically, that Democrats are stupid (or more diplomatically, that they should know better than to make poor policy choices and then blame others).

When thinking about policy, you should learn that it's a red flag when opposing parties think their problems can be solved in different ways, but are unified in both blaming the same third party.



Do note that this is related to, but not quite the same as, concerns that American firms are holding a large proportions of their recent profits outside the country, and that these can be, will be, or should be, repatriated back into the U.S.

The reasons for that have a lot to do with tax systems requiring periodic reform, and the American tax system not having been updated as recently as many other countries. This has left us with both relatively higher corporate tax rates, and a bizarre system in which profits left overseas are taxed once, but taxed twice if they're brought back home.

But again, views on that commonly devolve to "Republicans are mean" and "Democrats are stupid".


These positions run into 2 problems when we look at the data.

The first problem is that the run up in corporate cash mostly occurred in 2000-4. Check it out:


(I could not position this chart properly. Not sure why).

Anyway, it's pretty clear from the blue line that corporate cash was lower in the 90's, went up by 2005, and then stayed there. We're not quite sure what the reasons for that are. What should be clear is that it isn't about Democrats and Republicans, or the performance of the economy over the last 8-10 years. The reasons have to do with corporate finance, and it's not required but if you want to learn more I drew this chart from Campello's "Corporate Liquidity Management" article.

There's an additional minor side point now that you've seen the graph. Both parties are attributing current weakness, in part, to corporate cash holdings. But then neither one can explain why things didn't start getting bad in 2000-4 when they were accumulating all that cash.

The second problem was noted by Summers in that article I quoted last week:

He also dismissed the idea that tax policy aimed at encouraging US companies to repatriate cash held overseas would provide a big boost to the economy. Trump had repeatedly championed this idea along the campaign trail.

"The vast majority of the companies who have large overseas cash also have substantial amounts of domestic cash," Summers said. "The reality is that cash that's brought home will be used to pay dividends, to pay back shareholders, to buy back shares, to engage in mergers and acquisitions, to rearrange the financial chessboard, not to invest in large amounts of new capital. It is a chimera to suppose that there will be large increases in capital investment as a consequence of that repatriation."†
Basically, firms could spend this cash on a lot of stuff, but what they're choosing to do is spend it on their own savings accounts. Can you imagine if both Democrats and Republicans went around saying that the problem with America was that people like you and I saved too much for a rainy day? We'd recognize that quickly as nonsense. But they point fingers at firms doing the same thing, and many people suspend any sense of reasonable suspicion.

The upshot of all this is that both Democrats and Republicans are likely to be disappointed with any plans that rely on changes in corporate cash holding. And, of course, politicians will probably blame the firms for this.

† You folks are bright, but relatively new to work at this level. How many of you know what chimera means in this context? How many of you looked it up as soon as you saw it? The internet is an incredible resource for making you smarter. Take advantage of it. I'll help you out this time around: chimera has multiple meanings, but in this context it's the fourth one down on this page.

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