|Corporate cash-saving equals economic strangulation
Monday July 25, 2005
Corporations around the world are undermining the raison d'etre of
business life. Instead of investing in their companies, they are
holding on to their cash and saving rather than spending.
This love of saving poses a bigger risk to the global economy than the
trade and current account imbalances between the United States and
China, argues Stephen King, the chief economist of HSBC.
Whether the companies are based in weak or strong economies, they are
keeping their high profits as cash rather than investing in new
business opportunities. The implication, says Mr King, is that they
simply do not know what to do with the cash.
Buoyant profits usually mean high levels of confidence and optimism
about the future. This translates into firms investing excess cash and
even borrowing to fund expansion. When companies borrow to invest,
they suck cash in from other sectors of the economy, including the
"This, in one sense, is why companies exist: they are better at using
people's savings than the people themselves are and, as a result, they
typically run a financial deficit to allow them to invest their
shareholders' and bondholders' money," Mr King says.
But at the moment, rather than investing excess profits, firms are
using them to pay off debt, boost pension schemes or return funds to
the shareholders. Interest rates around the world have been low over
the past five years and as companies used their profits to pay off
debts, consumers have spent more. Low interest rates led to higher
levels of household borrowing, both through unsecured loans and
rapidly rising house prices.
In the UK, however, the economic data is pointing to consumers
beginning to tighten their belts while companies are still hanging on
to their cash. Business investment and confidence levels are low. If
the consumer is not spending and the corporate sector is not
investing, the obvious question is where will economic growth come
from? With interest rates in the UK currently at 4.75% - higher than
both the US and the eurozone - the Bank of England's monetary policy
committee has the option of cutting interest rates to stimulate
Luckily, in the US, consumer spending is still strong, and business
investment has been better than on this side of the Atlantic. But if
either of these wobble, with interest rates at only 3.25% there is
limited room for manoeuvre. The eurozone is in the worst situation,
with rates at 2% and the most stagnant growth of all.
Unless businesses start investing their cash and if the consumer
remains reluctant to spend despite cheap money, the usual tools of
macroeconomic policy could be close to exhaustion, warns Mr King.