Cash Hoards Threaten Recovery


Many economists have observed the irony that sensible household economic policies--reducing personal debt and increasing savings--can be bad for the broader economy, particularly in a prolonged recession, when renewed consumer spending is needed to get businesses hiring again. Now two studies suggest that the same may be true for companies, which are holding record cash balances.

According to the Federal Reserve, U.S. nonfinancial companies reported holding some $1.8 trillion in cash during the first half of this year, the highest figure on record, even as the Fed and the Treasury Department are trying to figure out ways to get banks lending to businesses.

It's not that executives are being greedy or foolish. "Increased cash levels at many firms are the result of improvements in day-to-day operations and independent decisions made for the good of each individual company," says Cathy Gregg, a partner at Treasury Strategies, which recently surveyed 300 firms about why they were holding so much cash.

Gregg reports that 30% of companies actually plan to increase their cash holdings over the next 30 months, while another 47% plan to keep cash levels steady, and only 23% plan to decrease cash. Over the past six months, 40% of companies increased their cash holdings, 38% held steady and 23% decreased the amount of cash they were holding.

But Charles Mulford, a professor of corporate finance at the Georgia Institute of Technology's College of Management, says that the effect on the economy of such individual corporate behavior can be similar to the macro effect of consumers individually deleveraging.

"We're in a unique situation here," Mulford says. "It used to be that companies went into a recession generating cash, building inventory, and spending on [capital expenditures]. But this recession has been different." He says this time around, managers, who have "gotten much better at cutting costs," have reduced inventory, cut way back on capital spending, and are "eking out savings where they can find them." Companies have become "so risk averse" in the current environment that average capital spending has fallen to just 2% of revenues, which Mulford he describes as "subsistence level or less."

And he warns that with consumers in no mood to start buying again, until companies start spending their money, there won't be much job growth.

Mulford says current monetary policy aimed at keeping interest rates low won't help much if companies decide not to spend their bulging cash reserves because they don't foresee an economic upturn. He suggests that the government needs to turn to tax policy instead. "I think the idea, which has been raised by the Obama administration, of giving companies a year or two to write off the full cost of capital expenditures against taxable income, could give a significant boost to spending down that cash," he says.

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