“Companies are hoarding cash”, this week’s edition of The Economist writes, because they are reluctant to invest which “may have more to do with regulatory, financial and fiscal uncertainty than weak consumer demand”. In other words: companies are sitting on their money because governments are spending too much. That sounds contradictory. Companies are by and large quite happy with governments spending a lot of money, because that’s good for their business. I therefore think something else is going on. Companies are scraping in hard coin simply because they can no longer finance part of their running costs with bank credit as easily as they were able to until the credit crisis destroyed the credit market as we knew it.
Companies are usually thought of as huge buildings with mirror-like windows through which we cannot see from the outside, or as lifeless logos. As a result, we tend to forget that businesses are run by calculating humans.
These days consumer spending is down. So is investment spending – or spending in general, for that matter – by companies. “Wait a minute!”, you say, “consumer spending is up! Look at this, for instance!” Ah, but look at where we came from. And the news coming out more recently is more bleak – that is to say, during the months of the second quarter, when the world economy was rocked by a confidence crisis due to fiscal, liquidity and solvency crises originating in Europe, and then spreading to all deficit nations.
In the first quarter of this year companies spent money on equipment and software. That’s Microsoft’s Windows7 kicking in. Yes, a lot more happened but I’m positive this had a major impact. After the replenishment of stocks in the third and fourth quarter of 2009, which saw a bump in spending, came the replacement of equipment, such as electronic equipment on the work floor: computers. Windows Vista was a disaster, companies had put off replacing the Windows XP desktops and laptops for years. But Windows7 seems a stable product, and companies finally had some money to spend after their deep and harsh spending cuts performed during the panic of the first half of 2009. And XP had really become obsolete as an operating system, especially after Microsoft essentially killed its support for it. After replenishment came replacement.
But were the companies also expanding, investing? Were they hiring new staff, setting up new operations? All evidence points to a ‘No’. Unemployment benefits requests did not come down by meaningful numbers (cleaned for US Census-effects). Capital spending levels are nowhere near those of 2007 and early 2008.
Companies cut spending in 2008 and 2009. As a result, profits went up. That money wasn’t spent. If anything, money was hoarded to finance the next round of spending cuts and reorganisations. And the companies are still raking in money, keeping costs low, not investing. So what’s going on? Are the companies really bringing that money to the bank, storing it on savings accounts? Well, why should they? Interest rates are very low, saving money isn’t very inviting. So where is the money going?
Most likely, it’s being used like it always was before the Great Credit Fest, which ran from the late 1990s all the way upto the credit crisis: to pay for everyday expenditure that keeps companies running.
Again, interest rates are low. While that may make saving money unattractive, it should make borrowing money more easy. But it hasn’t. Banks are more reluctant to borrow money to both consumers and companies. That is to say, the credit business has returned to more normal conditions. Banks take more time to consider credit requests, they demand more information and they’ve become a lot more critical of proposed business plans and models presented to them – just like they’re more critical of consumers who want to buy a house.
During the late 1990s companies were pressed to deliver more dividend to their shareholders. Interest rates were kept low, and it became attractive to finance running operations with credit from banks. The ‘money mix’ – the mix of money flows from their various origins – changed: the percentage of borrowed money rose relative to the company’s own cash. Injecting cheap liquidity from outside freed up money which was used to invest or paid out as dividend. Next came expansion, for which borrowed money was also used.
All that has changed. Companies aren’t hoarding cash only because of some fear about the future, but because the money mix within the companies has returned to normal, pre-1990s levels. The humans running the companies are once again learning how to run things with clean cash on hand, not with credit. They have to. If a company’s running operations used to be financed by rolling over loans for 10, 20 or even 80 or 100% of the running costs, then those companies are now busy retooling the money flow to those operations.
Like consumers, the humans running the companies are learning to stop resorting to credit cards. The question now is when the companies will be done rearranging the money mix and will begin to start investing again. If companies were financed for 10, 20, 30% or even more, that could take some time. As always, we’ll have to look to the end of the third quarter and the holiday season consumer spending in the fourth of this year.