FT Alphaville in New York continues to feel stuffed and lazy after our Thanksgiving feast, so we fully intend to parasitically mooch off the hard work of other bloggers for a big part of this post.
But first, recall that we have periodically reported on the cash-hoarding tendencies of US non-financial corporates this year, mostly in search of explanations for why these companies haven’t used more of their impressive earnings since early last year to invest in capital and (especially) labour. They have chosen instead to hold hold more cash than would historically be considered normal.
As Moody’s wrote at the end of October:
The balance sheets of U.S. non-financial companies are in good shape, in contrast to government and household balance sheets. Some $943 billion of cash and short-term investments sat in their coffers at mid-year 2010, compared with $775 billion at the end of 2008 (Figure 1). Corporate America could use these cash holdings to cover a year’s worth of capital spending and dividends and still have $121 billion left over.
You can see our earlier post for more detail, but the reason for the excess cash was a combination of a) needing it to deleverage after the borrowing binge of 2005-2008, b) the desire for a safety cushion during uncertain times, c) the fact that as much as a quarter of the cash is located offshore and won’t be repatriated soon, and d) the simple worry that demand for their products won’t return anytime soon.
Now to the matter at hand. Earlier this week came the news that corporate profits had reached a historic high, having climbed precipitously for seven straight quarters. Combining this sustained rise with already-strong balance sheets, surely a renewed climb in capital expenditures is inevitable, if somewhat lagging?
Well, not necessarily. For one thing, as Matt Yglesias notes, when adjusted for inflation, the profits numbers look less impressive , and actually haven’t superseded the historic peak — an accomplishment which at any rate is quite common during expansions. Like every other part of the economy, they haven’t fully recovered yet.
But Justin Fox did a bit more statistical digging of his own, dividing profits as a percentage of national income, and found that there is even more to the story:
Pre-tax domestic nonfinancial corporate profits — a mouthful, but also seemingly a fair measure of the underlying health of business in America — are nowhere near record levels as a share of national income. They exceeded 15% of national income once in the late 1940s, and repeatedly topped 12% in the 1950s and 1960s; in the third quarter of this year, they were 7.03% of national income.
This might go some way toward explaining the seeming disconnect between booming corporate profits on the one hand and a very cranky business community on the other. For much of the business community, profits aren’t that high by historical standards. These people have every right to be cranky.
Who is doing better? Well, according to the BEA’s data, financial industry profits and “rest of world” profits — that is, the money U.S.-based corporations make overseas — are relatively much higher now than they were in the 1950s or 1960s. And the taxes paid by corporations are much lower now than they were then, as a share of national income.
So the reason that corporate profits are near their all-time highs would appear to be that financial corporations (mainly big financial corporations) and multinationals are making lots of money and paying less of it out in taxes. Hmmmm.
To be honest, we’re not exactly sure what this means in terms of businesses starting to use some of their retain earnings to invest rather than storing up liquid assets.
We already knew from Rebecca Wilder that until earlier this year, all of the decline in the total corporate financial balance was coming from the financials — the non-financial companies continued to play it safe.
Yet this graph (also from Yglesias) suggests even the non-financials are starting to reduce their cash pile and invest, if only slightly:
Let’s hope so, because at least through the second quarter of the year, capex remained well below the pre-crisis trend, while dividends had recovered and cash was obviously higher:
Unfortunately, quite a few companies are opting to do other things with their money. In addition to paying out dividends, they are also buying back shares, sometimes even tapping debt markets and playing the debt-equity arb to do so — and Moody’s expects a lot of these companies to start using their money for more acquisitions.
Maybe this will change. Maybe the Fed’s latest round of quantitative easing will succeed in raising inflation expectations, generating demand and convincing companies to start investing again. Or maybe the economy, as Greg Ip reckons, is poised to naturally recover more strongly than we’re all anticipating. (And if that happens, companies won’t need any additional incentive to start using their money.) But really, who knows?
And the stakes are high. The OECD’s latest economic outlook essentially pinned the hopes of the American economy on a surge in business investment, which it believes is inevitable following the “record” corporate profits of the past year.
But it’s not inevitable. Right now, nothing is.