Is the Mountain of Corporate Cash an Illusion? (Part 1)
With the global economy sputtering and employment growth still stagnating, the supposedly high cash levels accumulating on U.S. corporate balance sheets are drawing heightened attention — and plenty of criticism. Politicians would prefer that U.S. corporations deploy their cash to help thin the ranks of the unemployed. Investors, too, are uneasy: Many have accused the business community of lacking “animal spirits,” and have demanded that corporations either reinvest their cash in projects that earn a higher return, buy back their shares, or return the capital in the form of dividends.
The usual discussion of the corporate cash mountain compares growth on a year-over-year basis. According to the Federal Reserve’s Flow of Funds Guide published in mid-September, at the end of the second quarter of 2011, U.S. nonfinancial corporations held liquid assets of $2,047.1 billion, up 24.37% over the prior year. At a time of negative real interest rates, this rate of cash accumulation certainly does seem alarming.
But is it really? The answer, it turns out, is probably not. In fact, most of the alarm about excess cash accumulation seems to be a simple artifact of how the U.S. Bureau of Economic Analysis and the Federal Reserve report their data: Both organizations publish numbers in press releases going back only to 2008. To analyze a longer sweep of history, analysts and commentators would need to dig deep into both organizations’ websites, and it seems that few do. Instead, they have anchored to year-end 2008 data as the basis of comparison — a period when cash balances were artificially low. At the time, with short-term credit markets seizing up and U.S. corporations suffering through the worst economic quarter since the Great Depression, many businesses dramatically drew down cash balances in an effort to maintain their operations.
Even just slightly more complete Federal Reserve Board data tell a different story. As shown in the table below, growth in liquid assets from the 2008 low to the second quarter of 2011 was 46.33%. But growth in liquid assets since 2007 was a more palatable 34.08%. On a compound annual growth rate (CAGR) basis, the results diverge even more: Growth in corporate cash since 2008 was 16.45%, compared to a more modest 8.74% since 2007. Comparing current liquid assets to the 2008 trough clearly leads to a skewed result.
Total Nonfarm, Nonfinancial Corporate Business Liquid Assets (Billions)
|2007||2008||2009||2010||2Q 2010||2Q 2011|
Sources: Federal Reserve Board; CFA Institute.
For a more accurate picture of corporate cash balances, it is perhaps more reasonable — and revealing — to use corporate profits as a basis of comparison. After all, profits are the major source of cash accumulation for nonfinancial businesses. So if cash balances are growing faster than profits, wouldn’t that be a strong indication that corporations are in fact “sitting” on their cash?
More on that analysis in my next post.