Tuesday, October 5, 2010

Corporations are Hoarding Cash and Keeping Their Powder Dry

There is a great deal of discussion these days about all the cash that corporations are holding. This issue made the lead article in the Wall Street Journal on Monday, October 4. This issue is also connected with the move by many corporations to issue new debt with interest rates so low. This made the front page of the New York Times on Monday, October 4. (See Graham Bowley, “Cheap Debt for Corporations Fails to Spur Economy,” http://www.nytimes.com/2010/10/04/business/04borrow.html?_r=1&scp=4&sq=graham%20bowley&st=cse.)

People continue to believe that the issuance of more debt and the hoarding of more cash will eventually lead to more corporate investment which will spur on the economy and help achieve the recovery everyone wants so badly.

A recent commentator to this blog is skeptical of such occurrence because the amount of debt still outstanding in the corporate sector far exceeds the cash that is being held.

First, let me say that, like the commercial banking sector, there are some corporations that are piling up cash and issuing debt to pile up cash, and there are many more corporations that are facing solvency problems and have way too much debt for them to handle.

That is, there is a huge separation at this time between those banks and corporation that have and those that are drowning.

The macro issue of the relationship between debt and cash is not as relevant as is the micro issue of who has the cash to play with and who is still way over-leveraged.

The United States economy is at the point where a major re-structuring of the manufacturing and financial base is taking place. I have written about this over and over again and I have emphasized that the economic policy of the federal government has created a credit inflation over the past 50 years that has resulted in the need for this massive re-structuring.

Who would have ever imagined twenty years ago, for example that General Motors would ever need to be bailed out as it was last year? Who would have ever imagined the need for the major pharmaceuticals and other industries to re-structure as they have been doing, consolidating, and scrambling for their lives?

And, as for the smaller companies? They seem to be stuck. They cannot raise funds from either commercial banks or from the bond markets. As Bowley emphasizes in his New York Times article, “Smaller companies continue to have trouble borrowing, and most of the new financing is limited to bigger corporations.”

The same thing is happening in the banking industry. The bigger commercial banks (the largest 25) prosper; many of the smaller commercial banks (about 7,800) are just holding on.

So we have this huge bifurcation of both the manufacturing sector and the financial sector. One part of each is piling up cash while the other part is just trying to keep its nose above water.

It is my bet that the companies that are building up their cash hoards are just waiting for the opportunity to sweep in and acquire firm after firm that are extremely weak. It is my guess that these companies are waiting for the right time to pick up their exposed brothers and sisters for a song.

They see the opportunity to participate in a complete re-structuring of the economic framework in the United States. The move depends upon two things. First, it depends upon the realization on the part of the weaker companies that they have little or no future without being acquired. Second, it depends upon some of the uncertainty surrounding the economic policy and regulatory philosophy that the federal government is going to finally decide upon.

The debt issuing and cash hoarding that is going on in both the banking sector and the manufacturing sector is not in preparation for hiring more people and buying more equipment. The corporations issuing debt and hoarding cash are preparing to build themselves by acquiring the assets and intellectual property of those companies that are not going to be able to make it on their own into the future.

Note, that this strategy WILL NOT increase jobs and investment in the near future. The strategy, like most mergers and acquisitions will result in cutting down and stream-lining the merged or acquired organizations. This strategy will result in more layoffs and the elimination of the excess capacity in the merged or acquired firms.

These activities will take several years to complete and, consequently, will not produce much economic growth over this time period.

Also, in both the manufacturing industry, as well as in the financial industry, this strategy will result in the big getting bigger. It seems as if the economic policy of the Obama administration is just exacerbating the distance between the small and the large. But, there is little that can be done now except attempt to create a “stifling” regulatory structure that clamps down on all mergers and acquisitions and creates an environment that is very unfavorable to business.

So, my conclusion is that the corporations that are issuing debt and building up their cash holdings are just increasing their ammunition for the up-coming economic re-structuring.
And, until that time occurs, they will just hold on to their ammunition and keep their powder dry

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