Companies Flush With Cash

The recession has been over in most countries for more than a year now, and as economists continue to decipher how and why this downturn differed from others, an interesting anomaly has emerged. While nations like the United States, Great Britain, and Japan are saddled with debt, companies in the U.S. and Europe have more than $1.5 trillion sitting on their respective balance sheets. In normal times, this abundance of cash would be good for the economy, as companies would invest, expand capacity, and create jobs. And indeed, over the next year, analysts say there may be a slight uptick in spending as cash-heavy firms turn to mergers and acquisitions, dividend payments, capital expenditures, and a variety of job-creating investments, particularly in high-growth countries such as China, India, and Brazil.

But what's also new this time around is the extreme caution firms have retained about spending, even as the recovery continues to unfold. In the U.S. in particular, where demand is low and uncertainty over taxes and access to credit continues to loom large, firms are simply sitting on piles of cash. "Companies were caught in a near-death experience," says Ruchir Sharma, the head of emerging-markets equity at Morgan Stanley. "They are overcompensating…because they were caught short in the crisis." Until that perception changes, bloated corporate coffers may become the new normal. As a consequence, so too may higher unemployment and slower growth.

Even before the recession began, companies had been stockpiling cash for decades. Researchers from the University of Arizona and Ohio State University found that the average cash-to-assets ratio for industrial firms in the U.S. rose by 129 percent from 1980 to 2004. The 2008 recession, with its massive liquidity shock, compounded this ongoing phenomenon and sent tremors through the market. Firms shed workers, increased productivity, slowed production, and reduced inventories—everything necessary to improve their balance sheets, which become flush with cash.

The recession ended in the summer of 2009, yet many firms have continued to stockpile greenbacks due to continued uncertainty over the economy, taxes, and regulation. As of November, Microsoft alone had $43 billion on hand. Meanwhile, unemployment remains at close to 10 percent, and consumer demand—once the engine that drove a large percentage of the economy—has sputtered. "Companies want to ensure they have contingency," says Mark Spelman, the global head of strategy for Accenture. "Even industrial firms are concerned about capital markets [and are] using cash to hedge against risk," says Thomas Bates, a professor of finance at Arizona State.

The recession—and subsequent sovereign debt crisis in Greece—has led European firms to hoard cash as well. From 2008 to 2009, the corporate saving rate in the euro zone went up by 4 percent. Among the biggest cash hoarders were firms in Great Britain, where government debt has been a major concern. Even Germany, which weathered the recession far better than its continental counterparts and seems to have its fiscal house in order, saw the net savings rate of its companies increase.

Over the next year, however, there will likely be a slight increase in spending, as consumer confidence grows and banks become more willing to lend. But analysts say it's not likely to be substantial enough to result in a major uptick in new jobs. In the vast majority of cases, firms will increase dividends or upgrade their technological systems and equipment, which in some cases will replace human workers. "Machines are cheaper than people," says David Wyss, an economist at Standard & Poor's. In some sectors, such as technology, where the mountains of cash are the largest, many expect to see an increase in merger-and-acquisition activity, yet that too tends to reduce rather than increase employment—at least in the short term.

Even when corporate coffers do result in job growth, most of it is likely to take place overseas, particularly in emerging markets. The major reason: better growth prospects. Countries like Brazil, India, and China came out of the recession largely unscathed. They all have GDP growth rates well above that of the United States and Europe. They have younger demographics, an emerging middle class and consumers who are not saddled with debt. "A lot of companies are actually hiring," says James Manyika, the director of the McKinsey Global Institute. "Quite often…it's just…not here [in the U.S.]."

For American firms at least, taxes are another reason to start putting more of their business overseas. Companies in the S&P 500 Index make more than 40 percent of their profits abroad, according to the Investment Company Institute. And between 25 to 60 percent of all their cash is currently held outside the U.S. Firms that choose to repatriate their money would be subject to taxes, and America has the second-highest corporate tax rate in the world. "It may actually be cheaper for these companies to tap the domestic credit markets than to draw on their offshore profits," writes John Bilardello, the head of global ratings at Standard & Poor's, in a recent note.

None of this is to say that job creation will grind to a halt or that the U.S. and euro zone will lose their competitive edge; it's simply a question of extent. The U.S. economy, for instance, added 151,000 thousand jobs in October, and is expected to grow at a rate of roughly 2 percent on the year. Meanwhile, growth from emerging markets—while far from a massive, job-creating catalyst—is still likely to benefit developed countries and a subset of domestic workers; the latest technological gadgets may be assembled in China, but they are still designed in Silicon Valley, their marketing plans are still drawn up in New York or London, and that's not likely to change.

Nevertheless, anyone waiting for a return of the full employment and go-go growth of the 1990s will likely be disappointed. "I don't think you can criticize consumers for not spending," says Wyss, the S&P economist. "We were living way beyond our means." As consumers and governments become increasingly forced to live within them, analysts say companies will find it hard to justify massive investment; in the wake of the recession, they've learned how to do more with less. And that could mean a self-perpetuating cycle of fewer jobs added, weak consumer spending, and a less robust economy in both the United States and Europe. As Manyika, the McKinsey director, puts it: "We may be stuck with sluggish growth until it feels normal."