Yesterday’s discussion regarding Jeff Gundlach’s opinion that the US economy would default raised an excellent question from a reader. In the article I mentioned that private sector net savings are government deficit. Steve Randy Waldman at Interfluidity (in a far more detailed look) beautifully described what I was trying to communicate: net household financial income = current account surplus + government deficit + Δbusiness non-financial assets. The question from the reader was this: if the above equation is true then where is all the private sector surplus? This question was masterfully answered by Rob Parenteau the other day on Naked Capitalism. His conclusion:
“Remember the global savings glut you keep hearing about from Greenspan, Bernanke, Rajan, and other prominent neoliberals? Turns out it is a corporate savings glut. There is a glut of profits, and these profits are not being reinvested in tangible plant and equipment. Companies, ostensibly under the guise of maximizing shareholder value, would much rather pay their inside looters in management handsome bonuses, or pay out special dividends to their shareholders, or play casino games with all sorts of financial engineering thrown into obfuscate the nature of their financial speculation, than fulfill the traditional roles of capitalist, which is to use profits as both a signal to invest in expanding the productive capital stock, as well as a source of financing the widening and upgrading of productive plant and equipment.
What we have here, in other words, is a failure of capitalists to act as capitalists (emphasis added).”
This fact was best portrayed yesterday by Edward Harrison who writes the excellent Credit Writedowns website. Edward showed us just how much hoarding is going on at the corporate level:
I pulled a quick and dirty scan of some of the corporations with very high cash balances. As you can see most of the world’s largest corporations are flush with cash. They are literally hoarding billions. The problem of course, from an economic perspective is that these corporations, are in many ways, effectively debiting the system by not spending their retained earnings. Many of these companies have simply been amassing cash for years on end. Think paradox of thrift at a time when the consumer is struggling with an unbearable debt load. Not exactly a recipe for economic growth….
The conundrum here is what can be done about this? Is this even a problem that can be solved? Should it be solved? What can we do to get capitalists to start acting like capitalists again? Rob Parenteau thinks he has a solution:
“What we have here, in other words, is a failure of capitalists to act as capitalists. Into the breach, fiscal policy must step unless we wish to court the types of debt deflation dynamics we were flirting with between September 2008 and March 2009. So rather than marching to Austeria, we need to kill two birds with one stone, and set fiscal policy more explicitly to the task of incentivizing the reinvestment of profits in tangible capital equipment. A program to do so would include the following measures:
1) a prohibitive tax on retained earnings that are not reinvested with a 24 month period after they have been booked;
2) a financial asset turnover tax that raises the cost to businesses of playing casino games in various financial asset markets, rather than reinvesting profits in the productive capital stock;
3) a reinvigorated public or public/private investment program that helps speed up the shift to, and lower the costs of production of new energy technologies.”
Very interesting stuff. In summary, a great deal of today’s economic woes lie with the fact that corporations are having trouble finding a good use for cash or remain fearful to put it to use for varying reasons. This isn’t a new phenomenon, but rather, something that has been building up for many many years. What exactly is going on here? What can be done about it? Does something need to be done about it?
I’d like to do something a little different today. Rather than stand on my soapbox and pipe off I wanted to open the floor to the readers. What can we do now to promote this money to start moving thru the economy again as opposed to collecting dust in bank vaults? What can we do to get capitalists to start acting like capitalists again? Should something be done? It’s time that we all start recognizing that we’re in this together (the mailman, the entrepreneur, the banker and even Uncle Sam). We all benefit the sooner we get out of this horrid recession. So what can be done to eliminate the corporate savings glut? What can government do in partnership with the private sector to promote economic activity? The masochists out there believe pain is the only answer to get us out of this mess. I think we’re more creative than that. How can we get capitalists to start acting like capitalists once again?
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.