Why ‘idle cash’ is a myth

How much Canadian companies are investing has nothing to do with the size of their cash reserves

by Stephen Gordon

(Getty Images)

Pop quiz: Summarize the relationship between the following decisions:

  1. How much a firm invests in new equipment and/or new construction.
  2. How a firm finances investment in new equipment and/or new construction.

If you answered “There is none,” you’re absolutely right: investment and financing decisions are completely separate questions. And you probably are as bemused as I am about the whole “too many firms are sitting on piles of cash instead of investing” meme. It makes as much sense as claiming that “too many firms are using Helvetica in their annual reports instead of investing.”

Mike Moffatt has a nice example explaining why changes in cash reserves are at best an uninformative measure for what’s happening to investment spending:

Take, for example, a company that takes out a loan for $5-million, uses $4-million for a plant expansion and holds the last million to insure against cost overruns and for future purchases of raw materials. This investment (with the associated loan) has, in fact, increased cash balances, not lowered them. Cash balances, by themselves, tell little about investment.

So if cash balances tell us nothing — or almost nothing — about investment expenditures, where can we look for information about investment expenditures? Happily, Statistics Canada collects and publishes data on — wait for it —  investment expenditures. If your goal is to understand what’s going on in investment spending, then you don’t need to bother with cash balances.

There are two interesting and important things to know about patterns in investment spending.

The first is the role fixed business investment has played — and is expected to play — in the recovery. Here is a graph the breaks down changes in GDP into its main components (clicking on the graphs opens a larger version in another window):

The sharp drop in investment spending was by far the most important factor in the decline in GDP during the recession. (Some may be surprised that net exports went up: the 20 per cent depreciation in the Canadian dollar did much to cushion the effects of the crisis. Something to think about the next time someone brings up the idea of a Canada-U.S. monetary union.)

There were two things policy could do to make up for this drop in investment spending. Governments could — and did — increase spending to make up for the shortfall in aggregate demand. And the Bank of Canada could — and did — cut interest rates as far as they could go, and promised to hold them there for at least a year. Happily, Canadian policy makers had better luck than most: investment spending started to rebound in the second half of 2009.

But not all components of investment spending rebounded at the same time:

Residential construction — which the national accounts classify as part of investment spending — rebounded first, but it stopped making significant contributions to the recovery in mid-2010. Since then — and especially after the governments started cutting back in  2011 — policy makers have relied on the handoff to business investment in non-residential construction and in machinery and equipment to sustain the recovery. And up until mid 2011, that’s what happened:

If you actually look at the investment data during the recovery, the immediate impression is not one of firms’ sitting on their hands and not investing. You might even be impressed that firms have re-established pre-recession levels of expenditure in a very shaky global economic environment.

To be sure, the pullback in machinery and equipment spending in the latter half of 2011 was not welcome news. It’s not hard to come up with a story for why it happened: concerns about Europe, the U.S. and even China made for an increasingly risky environment in which to make investment decisions.

So that’s the first point: much of the recent talk from Mark Carney and Jim Flaherty can be viewed as attempts to cajole firms into resuming the pace of investment that had been established earlier in the recovery. Again, this narrative has nothing to do with cash balances.

A second point is the longer-term concern that Canadian firms have a tradition of under-investment, and providing workers with higher-quality tools and equipment would go a long ways in addressing Canada’s chronic problem of low and sluggish productivity. I’ll have a lot to say about that in future posts — it’s an important subject — but again, it has nothing to do with cash balances.




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Why ‘idle cash’ is a myth

  1. Eric Schmidt/Peter Thiel debate:

    “Google is a great company. It has 30,000 people, or 20,000, whatever the number is. They have pretty safe jobs. On the other hand, Google also has 30, 40, 50 billion in cash. It has no idea how to invest that money in technology effectively. So, it prefers getting zero percent interest from Mr. Bernanke, effectively the cash sort of gets burned away over time through inflation, because there are no ideas that Google has how to spend money.”

    “But, if we’re living in an accelerating technological world, and you have zero percent interest rates in the background, you should be able to invest all of your money in things that will return it many times over, and the fact that you’re out of ideas, maybe it’s a political problem, the government has outlawed things. But, it still is a problem.”

    “What you discover in running these companies is that there are limits that are not cash. There are limits of recruiting, limits of real estate, regulatory limits as Peter points out. There are many, many such limits. And anything that we can do to reduce those limits is a good idea.”

    http://tech.fortune.cnn.com/2012/07/17/transcript-schmidt-thiel/

  2. Great post. Good point about “idle cash”, which seems to be a talking point fad these days.

  3. I don’t think Mr. Carney’s argument was that companies shouldn’t have cash reserves. I’m pretty sure he meant that Canada pursued a policy of reduced corporate taxation and low interest rates at the behest of private sector advocates who claimed they would invest and create jobs. The government is reducing its spending (and jobs) to cover the shortfall in revenues and the private sector isn’t making up the difference. Hard to keep claiming money is more productive in the hands of corporations when they don’t invest it and don’t pay dividends to shareholders who might. Might be better spent on education and transportation.

  4. This blog post is interesting, and an extension/summary of a discussion underway over at WCI. So, allow me to summarize my rebuttals to a topic clearly venturing into Finance, an area separate from Economics.

    First points of agreement. Absolute CASH levels, in themselves, are not indicative of under/overinvestment. They have to be put in context. So, one balance sheet measure would be “current ratio” defined as current assets/current liabilities. If current ratio is going up over time, this can indicate conservative investment/dispersal strategies.

    Secondly, using high level Statistics Canada data over the period of 2008-2012 has some very serious limitations. This is a rollup of all industries- a consolidation of very different sectors of the economy. And what has been notably happening over the past decade that may affect the consolidated numbers? Booming investment in the Oil and Gas sector, while the manufacturing sector downsizes. I think it would be a tough argument to make that the O&G sector has been conservative or sitting on cash. Remove that sector from the high level study and you may get a completely different story. In other words Analysis has to be done sector by sector.

    SG closes with:

    “So that’s the first point: much of the recent talk from Mark Carney and Jim Flaherty can be viewed as attempts to cajole firms into resuming the pace of investment that had been established earlier in the recovery. Again, this narrative has nothing to do with cash balances.”

    I agree partly with the first point. In response to a press conference question, Carney replied with:

    1) The increasing levels of CASH [beyond what is prudent] is “dead money”. He did not quantify the amount. And he reiterated a fundamental principle of Finance: “If the CASH can not be effectively used by management, it should be returned to the shareholder who can decide for themselves how to use the money.”

    2) He suggested that firms may be being overly cautious, concerned about what is happening worldwide, and advised them that their caution may be unfounded. And suggested the B of C, and financial institutions, recognized as having the best financial system in the world, would be there for both good times and bad.

    But I offer a qualified difference with the second. The data provided in this analysis does not support that statement. The CASH account is relevant to a given firm IF both 1 and/or 2 apply, along with other financial measures of sectoral performance. It can’t bbe reviewed separately

    One presumes that both the B of C (that sets rates and forecasts growth) as well as the Dept of Finance (that sets tax policy and forecasts budgets/deficits) works with a much larger and detailed set of data (by comany/sector), and undertakes a much more rigorous financial analysis on a regular basis. They make forecasts, and if/when actuals exceed/don’t meet forecasts, they figure out why – either the forecast assumptions were wrong, or the economy (read business) did not respond as planned.

    Have the mandarins at B of C as well as Finance noted that things are not going to plan, and underinvestment was occurring prior to the now infamous press conference? Or was Mr. Carney caught off guard and was ad libbing?

    The issue was raised in the last election through an article in the G&M (a spirited rebuttal quickly posted by our moderator in Economy Lab) – so it’s not something new to the B of C , nor Finance. You’d think they’d have had an opportunity to look into the issue in a bit of detail since that time.

    I remain bemused as well.

  5. No matter how you slice it Canadian corporations haven’t been investing in upgrading their infrastructure.

  6. So what does this data mean for Keynesian theory in general? Their big concern is the liquidity trap right?

  7. TVO’s Agenda has interview with
    The Honourable John Manley, P.C., O.C., President and Chief Executive Officer of the Canadian Council of Chief Executives (CCCE).

    http://ww3.tvo.org/video/181555/sitting-cash

    He seems to agree cash is being held by corporations at increased levels.

    The follow-up discussion was not great, IMO.

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