Classical economic theory suggests that consumers and businesses, responding to market signals such as prices and interest rates, collectively spend, save or invest their money in the most efficient manner. But the growing trove of cash on corporate balance sheets, measuring roughly $2 trillion for the S&P 500 companies, suggests otherwise.
Not only are the funds being deployed extremely inefficiently, but the mountain of cash is in itself a troubling indication that something has gone badly wrong in the economic system. If productive, ongoing concerns operating in highly competitive markets don’t have any useful way to deploy the cash equivalent of 15% of U.S. GDP in their businesses, and are putting it instead into money markets and Treasury bonds giving them a negative return in inflation-adjusted terms, it means the economy is not functioning efficiently.
Moreover, if, as some analysts suggest, holding such huge cash reserves has become necessary for companies to protect themselves in a fragile financial environment or to survive the next catastrophic crash, then the economy has become unbalanced and dangerously volatile.
By historical standards, companies now are remarkably cash-rich. Some industries stand out as particularly determined to hoard cash, such as pharmaceuticals, high-tech and telecoms, but blue-chip balance sheets have become cash-heavy across the board. Many big companies now hold more than enough cash to pay off their debts. Microsoft’s cash holdings are more than four times higher than the size of its debt, while Google and Intel have enough cash to repay all their debt 10 times over.
This tendency goes beyond what should be considered prudent, especially at a time when companies continue to generate plenty of cash on an ongoing basis. Managing such hoards of cash is expensive. It requires building and maintaining a considerable cash management infrastructure, consisting of human resources and technology. But that’s only part of the problem. Corporate cash has to be invested prudently because investors will penalize companies for taking risks with their cash. This means that returns on investing cash are going to be meager in the best of times, well below profit margins achieved by those companies in their core business. But recently times have not been kind to savers.
An article at the online publication 24/7 Wall Street looked at how typical blue chips have built up their short-term holdings. The 10 companies highlighted had $288 billion in cash, cash equivalent and short-term securities, with Google holding $45 billion, Cisco $47 billion and Microsoft over $50 billion. Short-term rates have been at zero for the past five years, so that all that cash is earning virtually nothing and return on investment is substantially below the companies’ cost of capital.
Moreover, even long-term interest rates have been well below inflation. The yield on the 10-year Treasury bond has been hovering around 2%, compared to a CPI rate of nearly 3% in the early months of 2012. In other words, even long-term securities are losing money in real terms, and any further uptick in inflation could accelerate real losses for U.S. corporates. There could be additional losses if bond prices fall from their current historically high levels.
Holding so much cash, then, actually destroys value for shareholders. Even Apple, while making huge returns for investors over the past decade and a half, subtracted some of that value as long as it sat on close to $100 billion in cash, before it made the decision to return about half of its cash to shareholders by announcing that it would resume dividends for the first time since 1995.
Apple is a special case, and its business model has been so successful that it generates profits and cash flow well in excess of what it needs to invest in developing new products or safeguard its market position against competitors. Apple at least has joined a growing number of companies who are returning at least some cash to shareholders. But companies are still clinging to their cash, even though it represents inefficient use of their resources. Google announced after reporting its January-March results that it will, in effect, split its shares, rewarding shareholders but holding on to its cash reserves.
Still, it is puzzling and disturbing that, even amid fierce competition in research-intensive technological fields, high-tech companies are finding no better use for their cash than to pay dividends, buy back stock or hold cash balances — rather than investing in their businesses.
Some analysts have suggested that the reason why companies hold so much cash is fear of another economic collapse. After all, two major debacles hit the U.S. economy over the past decade and a half. Corporate executives are now much more attuned to the possibility of another bubble bursting. They are no longer going to listen to economists who tell them we’re seeing the emergence of a “new economy” as they did in the late 1990s, or that homeowners simply don’t default, as they did a decade later.
There is now considerable apprehension about possible bubbles in the bond market, in high-tech shares and throughout the Chinese economy. Decision-makers are aware that the world’s banking system is in a precarious state due to the ongoing euro-zone debt crisis. The realization has set in that the U.S. economy, far from being a mature, solid juggernaut, is a boom-bust construct.
Another major concern that corporate executives are expressing by holding large cash reserves is about the federal budget deficit and debt burden. In fact, the steady increase in corporate cash holdings is mirrored by the government debt burden, which has been growing at a rate of over $1 trillion annually since the start of the Obama administration. Corporate cash holdings also parallel increases in foreigners’ dollar and Treasury bond holdings, which stem from our persistent current account deficit. At the end of last year foreign holdings of U.S. Treasuries surpassed $5 trillion.
Imbalances can persist for a long time, but they can’t last forever. Cash cannot accumulate indefinitely on corporate balance sheets while U.S. debt mounts at the same time. Either the U.S. government will have to boost corporate taxes or it will cut spending. Higher taxes will reduce the pile of cash on corporate balance sheets directly. Spending cuts will slash aggregate demand (as has been the case in Greece, Spain and other southern European countries) so that lower economic growth will reduce corporate profits and cash holdings over time. In fact, this is exactly what is happening now: slow growth, low investment, low returns and inflation are eroding the real value of corporate cash.
A third alternative, albeit not a realistic one: the U.S. government goes bankrupt, defaulting on all those Treasuries in which companies are investing their money.
The U.S. is not going to default, of course, since its debt is denominated in dollars and it can always print more green stuff. But that will create other problems for corporations with enormous cash holdings. They are exposed to deflation of the U.S. Treasuries market as well as to an inflationary surge. The implications for the stock market, which has been in large measure buoyed by the cash holdings, are equally dire. Market capitalization of the S&P 500 index is approximately $12 trillion, of which $2 trillion, or a little more than 15%, comes from corporate cash.
Alexei Bayer is an economist and author based in New York City.