Slow growth and the knowledge economy: James Saft

November 26, 2013

Nov 26 (Reuters) – Corporate cash hoarding may simply be an
unintended consequence of the rise and rise of the knowledge
economy.

If true, this may help to explain not only why companies see
fit to pile up mountains of cash, but also why the recovery and
job growth are so weak.

A study published by the Federal Reserve in September tied
the growth of cash on corporate balance sheets to the rise of
so-called intangible capital, things like intellectual property
or the processes and experience that allow a company to deliver
a good or service.

“Using a new measure, we show that intangible capital is the
most important rm-determinant of corporate cash holdings. Our
measure accounts for almost as much of the secular increase in
cash since the 1980s as all other determinants together,”
Antonio Falato and Jae Sim of the Federal Reserve and Dalida
Kadyrzhanova of the University of Maryland write. (here
‘)

The rise of cash holdings by companies has been remarkable,
and a huge puzzle.

U.S. corporations now hold almost three times the amount of
cash they did in the 1970s. A variety of explanations has been
suggested; from the idea that companies are holding more cash
offshore to skirt taxes to accusations that executives won’t
make long-term investments because their own pay is tied so
closely to quarter-to-quarter profit measures. Those may be true
in part, but not the entire story.

Whatever the explanation, the economic impact of all this
cash sitting around is large. In an old-fashioned industrial-age
economic cycle companies moved strongly to invest coming out of
recessions, reacting to the high profit margins which recovering
demand drives. That investment, in turn, drove hiring, spending
and a virtuous cycle of growth.

This time round, however, while investment has recovered
somewhat, it has done so only slowly and still lingers near
where it would usually bottom out in past recessions.

For whatever reason, companies are simply happier piling up
cash, or using it to buy back shares, than to build out new
capacity.

The paper’s authors find a very tight relationship between
this cash build-up and the equally remarkable rise of intangible
capital. Intangible capital is, broadly speaking, all of the
things which allow a company to successfully compete and deliver
a good or service but which, unlike a loom or a building, can’t
be touched. Much of this, like research and development, both
uses technology and is driven by technology.

THE COLLATERAL PROBLEM

The rise of the Internet and computing has led to a
corresponding rise in intangible capital. Whereas intangible
capital was equal to only about 5 percent of net corporate book
assets in 1970 it has skyrocketed to about 60 percent by 2010.

Having more of your value invested in and represented by
intangibles creates some problems. For one thing, unlike a
factory building or a piece of machinery, you can’t pledge
intangibles as security against a loan. That makes borrowing
more expensive or even, if a company is in distress, impossible.
It follows then that firms with high levels of intangible
capital, which is just about everyone, would hold more cash in
order to keep their options open, either for investment or
acquisitions or simply to weather the inevitable storms.

In many ways this theory fits in well with the broad facts
of the past 15 years. You might argue that the unusually loose
monetary policy which produced first the dot-com bubble and then
the housing one was in part a reaction, intentional or not, to a
world in which companies are investing less and behaving more
cautiously. If company investment won’t lead to full employment,
then we’ll need something like a housing bubble or a social
media bubble to get people back to work. And with companies less
willing to borrow, more of the weight of growth depends on
getting households to borrow, be it for houses or cars or
college degrees.

A troubling thought is that with the rise of 3D
manufacturing, with its emphasis on intellectual property,
intangible capital will only become more important. That implies
that the cash hoarding and investment drought will only get
worse.

One partial potential solution might be to make it easier
for firms, perhaps through banking regulation, to borrow against
their intangibles. That might encourage them to keep less cash
on hand and invest more. It also, of course, might lead to banks
going bust when they find it impossible to measure, much less
seize and liquidate, the intangibles pledged against a loan.

In any event, it doesn’t seem like this is a problem which
can be solved by low interest rates, no matter how many times we
try.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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