MacroScope

Corporate responsibility: it’s time to start investing those record profits and cash piles

Corporate profits and cash piles have never been higher. But it’s not just an economic imperative that firms get spending and investing, it’s their social and moral responsibility to do so.

Three of the four sectors that make up the economy got battered by the global financial crisis and Great Recession:

    - Households: millions of workers lost their jobs, households retrenched their finances and times got extremely tough - Governments: they rescued and guaranteed the global economy and financial system at a cost of trillions - Banks: often vilified for their role in causing the crisis and apparent lack of punishment or contrition, they’re being forced to undergo huge structural change that will cost them billions

The one sector that flourished – even more than banks (and bankers) – is the corporate sector. By some measures, it has never had it so good – profits, cash reserves and share prices have rarely been higher:

The problem is, hardly any of that is being reinvested and relatively few are enjoying the spoils. Management and shareholders are sitting pretty, thanks to dividend payments and share buybacks. According to financial market consultant and author Andrew Smithers, US companies invest barely twice as much as they  pay out to shareholders. In the 1970s that ratio was as high as 15:1.

Smithers argues this is largely down to the distorted and myopic monetary short-termism of management incentives.

ECB rate cut takes markets by surprise – time to crack Draghi’s code


After today’s surprise ECB move it is safe to forget the code words former ECB President Jean-Claude Trichet never grew tired of using – monitoring closely, monitoring very closely, strong vigilance, rate hike. (No real code language ever emerged for rate cuts, probably because there were only a few and that was towards the end of Trichet’s term.)

His successor, Mario Draghi, has a different style, one he showcased already at his very first policy meeting, but no one believed to be the norm: He is pro-active and cuts without warning. Or at least that’s what it seems.

Today’s quarter-percentage point cut took markets and economists by surprise.

Strongly vigilant?

An alarming drop in euro zone inflation – to 0.7 percent from 1.1 percent – throws today’s European Central Bank policy meeting into very sharp relief. Not since the central bank cut interest rates in May has it been under such scrutiny.

No policy change is likely, and “sources familiar” are already talking down the threat of deflation. But the central bankers, who are mandated to target inflation at close to 2 percent, will be alarmed at the sight of price pressures evaporating. One need look no further than Japan to see the damage deflation can do, often for many years.

We reported last week that a strengthening euro has also come onto the ECB’s radar, given it could depress both growth and inflation, and that there are three camps – one wanting an interest rate cut (which we know was discussed at the last meeting), another preferring to keep the option open of another long-term liquidity flood for the banking system as was done last year, and a third wanting to do nothing.

Take-off has been delayed

Euro zone services PMIs and German industry orders data will offer the latest snapshot of the currency bloc’s economy which the European Commission now forecasts will contract by 0.4 percent this year and grow just 1.1 percent in 2014 – hardly escape velocity, in fact barely taxiing along the runway.

We know from flash readings for the euro zone and Germany that service activity expanded but at a slower rate last month. France’s reading crept back into expansionary territory for the first time since early 2012. Any revisions to those figures will be marginal leaving the focus more on Italy and Spain for which we get no preliminary release.

Italy’s service sector has been growing of late, according to the PMIs, while Spain’s has still been shrinking though at a slower pace. German industry orders posted a surprise 0.3 percent drop in August and are forecast to have grown by 0.5 percent in September.

What’s happened to euro inflation?

New European Commission macro forecasts for the euro zone and the EU have been given added significance by an alarming drop in inflation to 0.7 percent which has heaped pressure on the European Central Bank to ward off any threat of deflation.

There are myriad other questions – Will the Commission predict that Italy will miss its deficit target? What will it say to those countries in bailout programmes – particularly Greece, where the troika returns for a bailout review today, and Portugal? And what about France’s sluggish economy? PMI surveys on Monday showed it is acting as a drag on the euro zone recovery.

Against that backdrop, European Commission President Jose Manuel Barroso will speak at Frankfurt’s St. Paul’s Church, the seat of the first democratically elected parliament in Germany. He is expected to outline the political priorities of the European Union in the months to come and spell out his expectations of a new German government.

It’s all Greek

The EU/IMF/ECB troika is due to return to Athens to resume a review of Greece’s bailout after some sparring over budget measures.

Greece’s president and prime minister have said they will not impose any further austerity measures and hope that their ability to run a primary surplus will persuade its lenders to cut it some more slack on its bailout loans to make its debt sustainable. The EU and IMF say there will be a fiscal gap next year that must be filled by domestic measures, be they further wage and pension cuts or tax increases.

We had a round of brinkmanship last week with EU officials saying they weren’t going to turn up because Athens had not come up with plausible ways to fill a 2 billion euros hole in its 2014 budget. But on Saturday, the European Commission said the review was back on after the Greek government came up with fresh proposals.

Spanish sums

Spanish third quarter GDP figures tomorrow are likely to confirm the Bank of Spain’s prediction that the euro zone’s fourth largest economy has finally put nine quarters of contraction behind it, albeit with growth of just 0.1 percent.

Today, we get some appetizers that show just how far an economy with unemployment in excess of 25 percent has to go. Spanish retail sales, just out, have fallen every month for 39 months after posting a 2.2 percent year-on-year fall in September, showing domestic demand remains deeply depressed. All the progress so far has come on the export side of the balance sheet.

Spain’s public deficit figures, not including local governments and town halls, are also on the block. The deficit was 4.52 percent of GDP in the year to July and the government, which is aiming for a 6.5 percent year-end target, says it is on track.

The Italian Job

Italy has dropped out of the spotlight a little following the protracted political soap opera surrounding Silvio Berlusconi. But it remains perhaps the euro zone’s most dangerous flashpoint.

Prime Minister Enrico Letta now has some time to push through economic reforms, cut taxes and spending in an effort to galvanize activity. But already the politics look difficult.

Italy’s three main unions are to strike over the government’s 2014 budget plan. Former premier Mario Monti resigned as head of his centrist party after it supported the budget which he viewed as way too modest, lacking in meaningful tax cuts and deregulation.

Can they kick it? Yes they can

Click here for suggested soundtrack to this blog 

During the recent round of financial crises, policymakers have done a whole lot of “kicking the can down the road”.

The latest is taking place in the United States where a fiscal stalemate between Republicans and Democrats has forced the first partial government shutdown in 17 years.  It has also raised concerns about a U.S. debt default, should the government not meet a deadline this week of raising the debt ceiling. That has kept short-term U.S. interest rates and the cost of insuring U.S. debt against default relatively elevated.

While markets remain convinced there will be a last-minute deal – because the consequences are far to dire for there not to be – their performance has ebbed and flowed with the mixed messages from Washington.

A tale of two budgets

 

It’s deadline day for euro zone member states to submit their 2014 budget plans to the European Commission for inspection and we’re waiting on Italy and Ireland.

Having survived Silvio Berlusconi’s attempt to pull the government down, Prime Minister Enrico Letta’s coalition has to overcome differences on tax and spending policy.
The aim is to agree a 2014 budget that reduces labour taxes by some 5 billion euros but also undercuts the EU’s 3 percent of GDP deficit limit, so spending cuts will be required.

Rome has a chequered track record in that regard. The cabinet will meet at 1500 GMT to try and agree a comprehensive package. A Treasury source said the scale of tax cuts would be dictated by how much the various government ministries are prepared to forego.