Since 2001, U.S. corporations have built up large reserves of cash, prompting many to ask why firms are saving so much and whether it is a temporary or permanent state of affairs. Recently, firms have begun to dip into their cash reserves for accelerated shareholder payouts, cash-financed mergers and acquisitions, and increased investment. How can we better understand the link between cash and investment? On July 18 at the American Enterprise Institute (AEI), Governor Kevin M. Warsh of the U.S. Federal Reserve System gave an address on the recent buildup of corporate cash balances and the state of corporate balance sheets in the United States.
The buildup may be abating
After a long period of saving, it appears that U.S. firms are beginning to borrow more and spend their cash holdings, a trend that is likely to continue, Warsh said. A renewed focus on capital spending and on business expansion largely accounts for the recent shift, and this has been driven by growing external pressures to boost shareholder value. Continuation of these developments could lower the liquidity and credit quality of some corporations, but it is unlikely, at least in the near term, he said, to “put at risk their strong balance sheets or impede the solid expansion of business spending.”
Still, “should some emerging trends, such as lower required interest coverage ratios, gain traction, they might induce a more pronounced deterioration in credit quality than is currently expected,” Warsh said. He expects corporations to keep cash levels historically high as a cautionary measure because of geopolitical and economic uncertainties and a more rigorous legal and regulatory environment. According to Warsh, corporations in the United States have shown a remarkable ability to adapt and thrive in recent years despite these changes. He expects that they will continue to do so.
Increasing role of intangible assets
Could some part of the cash buildup puzzle, the AEI’s Kevin A. Hassett asked, be explained by corporate investments in intangible assets—those assets that are not physical—such as intellectual property? If, by pursuing profitable activities, firms are holding more cash, does an investment shortfall exist after all? Hassett argued that “perhaps the composition of investment in the economy has changed dramatically over time and is much more focused on intangibles.” He cited recent data showing that investment in intangible assets is now bigger than business fixed investment. If investment is defined more broadly to include intangible assets, then “this current expansion will look more like previous expansions” and will paint a more cyclically normal picture.
Warsh agreed it was “a very important point.” Although much of the capital investment in the late 1990s tended to be in business fixed investment, his sense now is that much of current investment—that is, new capital expenditure—is associated with previous investments, making more of technology, systems, and structures that were purchased in the past. Warsh said this could partly explain the productivity improvements we have seen, which “might have even accelerated during the past few years because of intangible investment in process improvement, and productivity investments are the result, boosting profit margins”
IMF External Relations Department
For more background on this topic, also see Chapter IV, “Awash With Cash: Why Are Corporate Savings So High?” of the IMF’s April 2006 World Economic Outlook (WEO), available on the IMF’s website (www.imf.org). Published copies of the full WEO are available for $49.00 ($46.00 academic rate) each from IMF Publication Services. Please see right for ordering information.
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