The popular savings-glut meme holds that the global economic imbalances exist not because Americans (and their government) spend too much, but because the rest of the world—in particular people in Asia—spends too little and saves too much.
But maybe the real problem isn't the frugal Chinese. Maybe it's frugal CEOs. It now appears that there is another savings glut right here in the U.S.A. In the past several years, instead of spending cash on hiring, new machinery, R&D, or dividends, CEOs have just been sitting on it. Huge, useless mountains of dollars, yen, euros, and pounds sterling.
Sure, emerging economies like China have been net savers, as savings-glut enthusiasts have noted. But when the economists at JP Morgan & Co. studied changes in net savings among the household, government, and corporate sectors in large economies they found that corporations in the G-6—the U.S., Canada, the U.K., Japan, Germany, and France—saved five times as much as all sectors in emerging markets combined. "Between 2000 and 2004, the switch from corporate dis-saving to net saving across the G6 economies amounted to over $1 trillion." This "unnatural" savings has been concentrated in the private sectors of the U.S. and Japan, where "the recent level of saving by corporates is unprecedented." In other words, corporations are hoarding. As the Economist noted in its own contribution to the corporate savings-glut meme last week, "normally companies are net borrowers, investing to boost future output and incomes, while households as a group are net savers, providing firms with the capital." JP Morgan's economists conclude that the corporate savings glut is more important that the Asian savings glut in explaining global economic aberrations.
On Monday, Gregory Zuckerman, writing in the Wall Street Journal'sinfluential "Heard on the Street" column, noted that the constituents of the S&P 500 "have accumulated more than $634 billion in cash, an increase of 54% in just over two years and up from $329 billion five years ago." Despite Microsoft's monster $33 billion special dividend last year, "the level of cash and cash equivalents (such as very short-term investments) held by companies in the S&P 500 has reached 7.7 percent of the market value of these large companies, up from 3.6 percent in 2000."
What gives?It's not just that CEOs have decided to be parsimonious. Increased corporate savings have been driven by macroeconomic factors. Corporations, particularly U.S. corporations, have been making more profits in recent years, thanks to tax cuts and low interest rates. But rather than using the profits to fuel spending sprees—as American consumers have—companies are paying down their debt, according to JP Morgan's economists. CEOs are having difficulty finding cheap companies to buy.
But psychology also helps explain the corporate glut. Executives are suffering from a hangover from the '90s bubble and its explosion. People who get plastered frequently forswear all drinking for a period, even though a glass of wine wouldn't kill them. Just so, companies that foolishly wasted money on big acquisitions in the late 1990s, or that faced the prospect of bankruptcy in 2001 and 2002 for lack of cash, remain in a defensive crouch. They are passing up risks and keeping the cash under the pillow.
The corporate savings glut is more manageable and less dangerous than the Asian-government-driven savings glut because CEOs are more likely to respond to market pressures and conditions than, say, the Chinese government. The JP Morgan economists already see signs that the glut may have peaked, noting approvingly that capital spending is rising even as the rate of profit growth is declining. (Translation: less corporate saving.) The Financial Times "Lex" column today reports that Japanese companies are uncharacteristically on the hunt for cross-border deals.
What's more, the market provides a nice self-correcting mechanism for the corporate-savings glut. If executives sit on too much cash for too long, management or outsiders will seek to take the company private in a leveraged buyout and use the existing cash to pay down the debt. And as Gregory Zuckerman noted, aggressive investors like Carl Icahn, who are targeting "cash-rich companies such as Siebel Systems and Mylan Laboratories, Inc.," stand up and demand that if management can't think of anything to do with the cash, they should give it back, either through dividends or stock buybacks. Indeed, Zuckerman notes that "buybacks surged 91 percent during the first quarter of 2005 and rose 64 percent during the past year."
In the end, CEOs will likely be motivated to unwind the savings glut not by outside pressure but by the factor that motivates them above all else: self-interest. The crew from JP Morgan notes that the corporate-savings glut is probably partially responsible for the equity markets' poor performance of late. All the cash sitting on the sidelines is a signal to investors that insiders don't think this is a great climate to be investing. Once corporate cash is put to work—prudently—to buy back stock, purchase other companies, or to invest for growth, that should help push stocks higher. And while a rising tide lifts all boats, it lifts the yachts of the bosses highest.