The great cash illusion

While much has been made of cash hoarding by the biggest US companies, debt levels are also at record highs. Unleashing the cash pile may have dire consequences.

We continue to hear that "there’s plenty of cash on the sidelines", but will it be the great growth booster many people hope?

Corporate cash reserves in the United States, for instance, are at record highs – $US1.25 trillion as of the end of the third quarter – but so are debt levels.

The first question that should therefore be asked is whether the cash is an illusion.

For example, if a bank lends $5 billion to, say, BHP Billiton, is the money the bank’s or BHP’s?

In reality we know the money belongs to the bank, but from a balance sheet perspective it will appear as cash in the assets section of the BHP accounts.

There’s nothing devious about that, but it means the notion of record cash on the sidelines needs to be taken with a degree of caution. Knowing they have to pay it back at some point, companies won’t invest much if there are worries about the state of the economy.

Corporate debt issuance in the US, like cash reserves, sits at a record high of somewhere between $US1.1 trillion and $US1.5 trillion, depending on which market information provider you prefer. That figure is remarkably similar to the level of cash sitting on US company books.

Worryingly, global (and US) sales of junk bonds this year also hit a fresh high, of over $US450 billion, with much of this through refinancing.

The problem comes in around three to five years when, one would hope, interest rates will be significantly higher. At that point, there will be a long line of companies hoping to refinance their loans and they will find debt is going to cost a lot more.

Given the cash reserves and likelihood of continued record profits in the next couple of years, that shouldn’t prove a disaster, but it will be a significant headwind.

The turbulence will be exacerbated as much of the cash on company books is in the hands of a select few. Apple, as an example, has cash reserves of almost $US147 billion, while Microsoft and Google have a combined $US130 billion.

This tells the tale of why markets cheered so wildly after receiving the latest statement from the Federal Reserve. It wasn’t that investors viewed the long-awaited taper as a sign of recovery. Instead, the market moves were a sign of relief that rates would remain at record lows through until at least 2015.

The federal funds rate has never been as depressed in history -- and yet the Fed is still so worried about the economy’s ability to stand alone under ‘normal’ circumstances that it can’t foresee a rate rise to even 0.5 per cent, or dare we say 1 per cent, within the next twelve months.

If you look back at the previous two recessions, the dotcom bust-related downturn of the early 2000s and the early 90s slump, the Fed never pushed the federal funds rate below 1 per cent and within 18 months of the low being hit, the Fed had begun to push rates back up.

In the wake of the Global Financial Crisis, not only have rates plumbed record low depths of 0 to 0.25 per cent, but they have stayed there for five years with no end in sight.

The term ‘unprecedented’ doesn’t do it justice.

Companies still can’t be sure how solid the recovery in the US really is, given the level of stimulus in the form of low interest rates and a Fed asset-purchase program that remains significant even with a modest $US10 billion-per-month tapering.

So when we ponder why all that cash is sitting on the sidelines two things should be at the forefront of any conversation: firstly, part of it is an illusion and secondly, companies simply aren’t confident in the future.

Should, however, predictions of a flood of cash entering the economy come true, it would likely lead to soaring inflation and a rapid rates response from the Fed.

And then we really would be in trouble.

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