Companies aren’t piling up cash at the rate they used to. Figures from the Bank of England next Thursday might show that the growth in their bank deposits has slowed to close to its lowest rate for six years.
If history is any guide, this should be a concern. Significant slowdowns in companies’ cash holdings in the past have led quickly to slowdowns in output growth; this happened in 2001, 2007-08 and in 2011.
There’s a common sense reason for this. Slower growth in cash flow causes companies to tighten their belts, either because it betokens worse trading conditions and hence a need to cut back, or because overstretched companies try to restore their cash balances.
Whatever the reason, there’s a danger of a vicious spiral. If many companies cut spending in an attempt to raise cash, their efforts will be self-defeating, because one firm’s spending is another’s income. That can lead to further cutbacks and hence to a serious economic downturn. This is the old paradox of thrift problem.
There is, however, a reason for optimism here. The link between corporate cash growth and industrial production has been weaker since around 2012 than it was before. Corporate cash holdings have soared in this time – by over 56 per cent since the end of 2012 – and yet we’ve had no boom in output growth. This is because companies have been building up cash not as preparation for expansion, but for other reasons. Among these are:
- Fear. The recession of 2009 taught managers that a sharp downturn is more likely than they previously thought. To protect themselves from this danger, they have piled up cash.
- Intangibles. In the modern economy, companies’ assets don’t just comprise buildings and machinery but intangible assets such as ideas and goodwill. These, however, cannot be used as collateral; bailiffs can seize a bottle-pressing machine but not your idea for a better machine. This makes it harder for firms to borrow. So they need to raise their own cash internally.
- Distrust. Some companies no longer trust banks to keep credit lines open in bad times. Because they can’t rely on credit to see them through hard times, they therefore need a stock of cash.
These factors help explain why companies have piled up cash in recent years even though it pays a nugatory interest rate. They also suggest a reason why we might relax about the slowdown in cash growth. It could be that what we’re seeing is not so much the sort of slowdown in free cash flow that in the past led companies to cut back, but rather the natural ending of these motives to build up cash. In the last five years, companies' bank deposits have grown at twice the rate of the economy. That’s clearly unsustainable. And as the late Herbert Stein said, if something cannot go on forever, it’ll stop*.
Perhaps, then, we shouldn’t worry about the slowdown in cash holdings. But only perhaps: “this time is different” are the most expensive words in the English language.
* This is much wiser than it seems. It warns us to be wary of big rises in asset prices, and of countries borrowing a lot from overseas. The big fall in bitcoin this year, and the crisis in Turkey, both fit Stein’s words.
