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« Strange Bedfellows | Main | Mon Dieu! It's Mark Steyn on the Convergence! »

Awash in Cash

The Wall Street Journal has run a couple of articles in recent days about how much cash corporate America is sitting on, and what they're doing with it. The most recent article though, while trying to cover all the bases, I think ends up shedding more heat than light. Still, they raise a number of interesting points.

First, this may mark a return to a normalcy, where dividends are more important than capital, which should prevent a return to a speculative market. In part, this is a result of the tax changes, but since we can't get Congress to make those permanent, watch out for post-2008, when those changes expire. While the Republicans are displaying political illiteracy, the economic illiteracy here is on the side of the Democrats, who can't figure out the difference between static revenue and incentives.

Now, when I was growing up, there was something called the "business cycle," and one indicator of the top of the "business cycle" was when companies had lots of extra cash. This may or may not have corresponded to "a vote of no-confidence in U.S. economic prospects," but that's a long way from eating your seed corn:

Some economists call the payouts this year an ominous development that may be stealing from future economic growth, since they suggest companies are having trouble spotting new products, projects or services they think will boost their growth. "These payments keep the economy growing more slowly because that money isn't flowing into capital spending," says Milton Ezrati, chief economist at Lord Abbett Funds in Jersey City, N.J. "If businesses are giving up on innovation, we have problems."

"Giving up on innovation?" That's a stretch. And remember, we're also talking about S&P 500 companies here, the larger ones, the ones that have a harder time innovating in the first place.

My worry is that the buybacks and dividends will leave these companies less able to weather the long-predicted recession. While the profits are at least partly a result of operational efficiency, the other half of survival is deep pockets, and those companies that don't have cash on hand may find 1) they've pushed up their stock prices above their real value, and 2) there's little room for more immediate efficiency gains.

This may be great for hedge funds and other short-term investors, who seem to be behind some of the payouts. But it's not such good news for long-term investors, now is it? It's a fine example of how shareholder interests are rarely aligned with each other, and why Stephen Bainbridge, who's been skeptical of both the existence and desireability of sharehold activism, has a point.

I'd be a lot happier with a company that declared a new (or larger) quarterly dividend, rather than a one-time payout, since it indicates some confidence in their operations. It also indicates an understanding that growth in economic value is more important than growth in any one revenue metric.

There's another, possibly darker side to this tucked away in the article, as well:

The outpouring of cash from corporate coffers in the U.S. is just one aspect of a world-wide phenomenon. With interest rates low, unprecedented amounts of capital are sloshing around the globe, in search of better returns. Pension funds, mutual funds and insurance-company accounts, for example, have some $46 trillion in assets, up almost a third from five years ago.

This is exactly the kind of dynamic that led to 1929. While we haven't seen (and aren't likely to see) anything like the speculative boom-and-bust from 1928-29, too much money in search of too few goods is a good sign that interest rates need to come up. Since right now, the US is the only place raising rates, we're in better shape than the rest of the world if credit does start to dry up - we have more room to lower rates. Still, that much extra money supply floating around has never been a good thing.

Indeed, the Journal itself noted this possibility several weeks ago:

If the world's central banks boost short-term interest rates more sharply than expected to ward off inflation, investors might start selling some of their riskier assets in favor of newly attractive short-term instruments. The Fed has recently stepped up its anti-inflation rhetoric, and the European and Japanese central banks have indicated they may raise interest rates in the coming year.

At the same time, corporations might revive expansion plans and become big borrowers again, pushing up long-term interest rates. Rising risk premiums, and thus falling asset prices, could then become self-reinforcing as leveraged investors unwind their positions to limit losses, driving asset prices down further and triggering still more selling.

...although the article went on to claim that a soft landing was a greater likelihood.

Still, we've been down this road before - many times - and historically, it hasn't ended well.

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