Amongst everyone from the average American to the politicians campaigning in November’s election, one of the ideas often discussed (to get the U.S. economy going) is how to convince corporations to invest the record amounts of cash they have in the bank.
Yes, corporations are holding record amounts of cash from their corporate profits.
But few are talking about the record amount of corporate debt they’re holding on their balance sheets.
U.S. corporations need to take advantage of record-low interest rates to borrow money to roll their old corporate debt over into new corporate debt at very low interest rates. This is simply wise money management.
However, since corporations are not investing in new capital projects to stimulate the economy, what is the need to create all this new corporate debt?
As of March 2012, U.S. corporations held a record $8.1 trillion in debt! This is a 6.6% increase over the same period last year (source: Federal Reserve).
As corporations mysteriously continue to pile on more corporate debt than needed, their cash amount from corporate profits is actually dwindling.
The same Federal Reserve report showed that, at the end of March 2012, corporations were holding record cash of $1.74 trillion from corporate profits. That works out to $4.65 of debt for every $1.00 of cash held.
When the credit crisis hit in 2008, corporations set aside large cash piles right up until 2009. That growth in cash from corporate profits started diminishing in 2010 and continued to fall off in 2011 and right into early 2012 (source: Wall Street Journal, June 7, 2012).
One of the reasons corporations are holding less cash is that they are earning fewer corporate profits. As I’ve been writing in these pages, after the crisis hit, corporations cut jobs and became as lean as they could. This resulted in strong corporate profits, despite the fact that sales were not increasing at a healthy pace.
Now that world economies are slowing and revenue growth is very hard to come by, since corporations can’t cut expenses any further, growth in corporate profits have to suffer, as is evident by the earnings reports being released this year. (See: Many Public Companies Predicting Soft Earnings for Balance of 2012.)
So, less cash on hand due to lower corporate profits, yet corporate debt continues to climb while capital investment falls…
This is not a recipe for economic growth. This is a recipe for a disaster should a recession hit again here in the U.S. (as I expect it to). It will mean even more job cuts, as corporations are forced to cut more to pay their debt from their dwindling corporate profits.
Big banks in the U.K. jumped on the news that the U.K. central bank would provide billions of pounds of new money to the big banks should Europe’s financial crisis take a turn for the worse.
Too bad the rest of the citizens can’t be in line for some freshly printed money…
There is no question that the U.K. central bank, much like Ben Bernanke here in the U.S., is concerned that, should big banks in southern Europe collapse, then it could cause a credit freeze in the U.K. and the U.S.—lending would especially dry up at the big banks.
The reason the U.K. central bank announced this step is that it does not want a “Lehman crisis” moment on its hands and wants to assure the markets that the U.K. central bank is ready to step in.
This is simply more money printing. Should such conditions visit U.S. shores, Ben Bernanke will perform the same actions here to help the big banks, as he alluded to in his latest testimonies.
The other initiative the U.K. revealed was its “funding for lending” program. Basically, the U.K. central bank will take any questionable loan from the big banks (or other lenders, for that matter) in exchange for cash.
The catch is this cash will only be offered if the big banks and other lenders funnel this money directly into consumer and/or business loans.
The U.K. central bank believes this program is so attractive for big banks that it could inject another 80 billion pounds into the economy.
The only problem with this theory is that the U.K. economy is in a recession and, much like the corporations in the U.S., U.K. corporations are not investing, as they do not have faith that economic growth will return. It doesn’t matter how low interest rates are.
We live in a truly interconnected world. The only way this initiative by the U.K. has even a chance of working is if the central banks from around the world would join in it.
With the U.K. and Europe in a recession, along with the slowdown in China and the U.S., U.K. consumers are very hesitant to take on new loans. Fear of losing their jobs makes them fickle, regardless of how low interest rates would be.
If it sounds like a vicious circle, dear reader, that’s because it is. When times are great, strong economic growth reinforces itself through big banks, consumers and businesses. When economic times are tough, everyone experiences a contraction, including big banks, consumers, and businesses.
If the U.K. central bank really wanted to jumpstart the economy, it should have done something different. When the money printing begins, it should find its way to the pockets of consumers instead of to the big banks.
Where the Market Stands; Where it’s Headed:
Stock markets continued their recent rally on Friday, as hopes are high that more money printing is ahead. Last Thursday, the Bank of England announced it is opening the money tap big time…investors are hoping other world central banks will follow.
Yes, they will follow. We will get QE3, maybe even QE4 and QE5. As world economic growth slows to a halt, central banks will need to pump liquidity into the system again. (See: Next European Country to Default: Why it Means More Money Printing.) That’s why I haven’t thrown in the towel on the bear market rally just yet.
What He Said:
“Any way you look at it, the U.S. housing market is in for a real beating. As I have written before, in the late 1920s, the real estate market crashed first, the stock market second, and the economy third. This is the exact sequence of events I believe we are witnessing 80 years later.” Michael Lombardi in Profit Confidential, August 27, 2007. A dire prediction that came true.