What’s Up with Carney & Flaherty?

Well, I’m still sifting through my thoughts trying to exactly understand what was behind the corporate “dead money” debate last week.  After a speech to the Canadian Auto Workers, Bank of Canada Governor Mark Carney drew attention to the rising amounts of cash in the bank accounts of Canadian firms and commented to the effect that Canadian firms were not doing enough to drive economic growth and create new jobs.  According to the August 22^nd Globe and Mail:

"The level of caution could be viewed as excessive," he said. Referring to corporate managers, he added, "Their job is to put money to work and if they can't think of what to do with it, they should give it back to their shareholders."

Interestingly enough, a few days later, Federal Finance Minister Jim Flaherty also chimed in with comments that Canadian business was not doing its part to spur the economy. In many respects, these comments seemed surprising and out of character coming from the country’s central banker and finance minister.  After all, if last week it was “dead money”, what will the Labour Day long weekend bring from this duo- Karl Marx’s line about capital as vampire-like “dead labour”?

All of this would indicate a concern that the economy is slowing down and doing worse than expected.  Yet, apparently Canada’s GDP growth in the second quarter of 2012 was 1.8 percent on an annualized basis and was driven largely by business investment and rising inventories suggesting that business is indeed spending some of its cash even as those reserves continue to rise.  According to the Statistics Canada report, business investment rose at the fastest pace since the second quarter of 2011.  The annualized change in real GDP though not stellar has been stable since the fourth quarter of 2011.

So what may be going on here?  While their comments were probably blown out of proportion given the traditional late summer slowdown in news, one has to wonder what drove these two to venture into this territory?  I suspect the concern is not so much the pile of cash that firms are accumulating but the message that it sends.  If firms are showing an excessive level of caution, what exactly is it that they are worried about and why might this message rattle Carney and Flaherty so much? 

Do Canadian firms expect a big jump in interest rates after the November American election and are therefore taking the precaution of having more than ample cash reserves to deal with their own financial needs and reduce future borrowing costs?  A jump in interest rates is also concern for the economy as a whole given the high mortgage and consumer debt levels that Flaherty and Carney have drawn attention to.  However, this is nothing new.  There has been talk of interest rates eventually rising for years now.

Do Canadian firms expect things to get much worse in the world economy?  The economic recovery has been very slow and interest rates are so low that little more can be done on that front to stimulate the economy.  As for fiscal stimulus, well most governments are engaged in the opposite right now.  Yet everyone knows the economy is not doing as well as it could and that the world economy is slowing down again.  Come the end of August, not only will Europeans be coming back from their vacations, but so will the Euro Crisis.  Again, all of this is not new information.

Or do Canadian firms expect that if there is another global financial crisis in the autumn, things are going to be very bad?  Are they concerned that central banks – including our own - may not be able to keep credit flowing.  This also seems unlikely but even a whiff of this sentiment may erode confidence in the financial sector hence prompting a strong moral suasion response from the central bank and federal government.  It is telling that a story in the August 28^th Toronto Star featured the following line:

“In a private meeting with executives after the controversy blew up, Carney reportedly said his remarks were taken out of context by the media. Also, he is making the point that if economic conditions deteriorate, the central bank will keep credit flowing, so there is no need for companies to hoard cash.”

Canadian firms building large cash reserves may have been interpreted as a sign of reduced confidence by business in the ability of the central bank and federal government to deal with the economy. By extension, this would include confidence in the ability to deal with what may be the next big financial and economic blowup simmering in Europe.  Such a development may have indeed spurred the assertive tag team pronouncements on ‘dead money’ given the central importance of business confidence when it comes to economic activity.  On the other hand, if there is such a concern about confidence in the economy, why draw attention to it in such a red flag manner?  I'm still sifting.

Comments

[Phil]

There's something I never understood, that maybe someone can explain to me. When a company hoards cash, it's not really hoarding cash, right? It's earning interest, so it's lending to someone, someone who's using the cash to invest or consume.

Why is that worse than the company investing the cash itself?

And even if the company *were* hoarding cash, couldn't the Bank of Canada compensate for that by printing more and lending it out?

Apologies if this is a silly question ... maybe this is something you learn in Macro 101, but, nonetheless, I don't know the answer.

[Theo]

Carney didn't make the comments about "dead money" in the speech.. He was asked about it by a Globe reporter at a press conference following the speech, suggesting his comments weren't scripted or may not have been thought it. My question is this: with all the government guaranteed mortgage credit that policy makers flooded the Canadian economy with, is it possible they actually may be responsible for crowding out non-residential business investment.

[Livio Di Matteo]

Thanks for catching that Theo. I've modified the post to "After" rather than "During the speech".

[Lord]

Phil
If companies and consumers are deleveraging, it isn't being lent to anyone else, and even BOC would have trouble lending more.

[Frances Woolley]

"they should give it back to their shareholders."

One thing that's interesting about this government is the extent to which they govern in the interests of the middle class/upper middle class as opposed to the ultra rich - Kevin Milligan has made this point on twitter in the past.

Suppose I'm a person with no company pension plan. My retirement savings are all in my registered plans - and I'm worried. The market has not performed well over the last couple of years. I'm not happy with the rate of return on my equities, and I'm not happy with the impact low interest rates are having on my bond yields.

What Carney is saying to companies is: pay out some of that cash in dividends and give it back to shareholders.

The thing is: if the money is given back to shareholders, the shareholders can invest the funds the way that *they* want to - buy shares in a new start-up, say - or the shareholders can spend the money the way that *they* want to.

Of course, as Theo's comments suggest, those shareholders might just use the funds to buy a condo in downtown Toronto, further inflating the real estate market, which may not be a good thing.

[Stephen Gordon]

I like Mike Moffatt's take: Suppose a firm borrows $5m and spends $4m on capital equipment. What happens to the stock of "dead money"? To the capital stock? To investment?

[Stephen Gordon]

Um, no. It means that looking at cash reserves is an uninformative measure of investment spending. You know what *is* an informative measure of investment spending? Investment spending.

[Patrick]

My memory is terrible, but I do vaguely recall Stephen convincing me that the "OMG our productivity sucks" meme was a little overblown.

Google found this: Why Canadian economists should worry less about productivity for me, but I also remember a post from Stephen about the effects of self-employment on productivity. I think the conclusion was basically that productivity growth excluding the self-employed has been pretty good, and the question then becomes: are the self-employed making an explicit choice (in which case presumably no policy response is required), or is something else going on. I did find a slightly old StatsCan paper on the subject (which I only scanned, so don't blame me if it's crap), but I just couldn't find Stephen's post. Maybe I'm imagining it...

[Patrick]

Putting aside the issue of whether their really are piles of cash sitting around, the mini controversy seems to me to be a bit odd. It seems to me that it the if the managers of a firm don't have a case to convince shareholders that keeping the shareholders money will generate the best returns possible, then their fiduciary duty is to give the money to it's rightful owners so *they* can try to do better. Being unsure about whether your 2014 bonus will cover the payments on your Veyron is just not a good enough excuse.

The cynical curmudgeon in me wonders if the managers are really just hoarding the cash until they devise find a way to allocate it to themselves.

[Bob Smith]

I wondered if they might be hoarding cash in the hopes of going on an acquisition binge at fire sale prices when Europe implodes. Certainly we saw that in 2009/10 when Canadian banks (and others) snaffled up all sorts of US banks and assets as US companies struggled (or failed) to raise cash. In that case, cash hoarding may be less an indication of concern about Canada's ability to keep credit flowing, than a (fair) assessment of the ECB's (in)ability to keep credit flowing in Europe.

[K]

Patrick: "The cynical curmudgeon in me wonders if the managers are really just hoarding the cash until they devise find a way to allocate it to themselves."

Then the LBOs show up. Oops.

The solution to this "problem" is to prevent management coddling governance structures so the "barbarians" can get to work.

[jt]

Seems the whole "debate" is short on numbers. Are Canadian companies holding more cash than, say, US companies (doesn't seem to be the case for BCE vs. VZ)? Could that be due to the commodity-heavy nature of the business structure in Canada (would expect more cash because of the highly-cyclical nature of funding)?

[Nathan W]

When businesses hoard cash, how do we know whether it's because they're looking out for short to medium term liquidity concerns or if they are holding on to the money because other relatively liquid options are paying peanuts and/or the investments alternatives aren't worth the risk? I.e., what's the difference between not making a bad investment and holding on to cash to manage cash flow.

[Patrick]

Managing cash flow is fine, to a point. But it is not managements purview to hold cash for no other reason than they have no idea what to do with it. If they can't put it to good use, their fiduciary duty is to return it to the rightful owners.

[Real_Interloper]

TBH, I think he was subtly referring to the Resource Curse. No coincidence he was speaking before the UAW and bad data from China, with backdrop of poor Canadian productivity

[Bob Smith]

Patrick, I'm not sure there is a fiduciary duty to pay dividends (in fact, since dividends are, as matter of corporate law,payable at the discretion of the boar, the only situation where not declaring a dividend would be problematic is if the business had been wound up). There is a fiduciary duty to make decisions in the interest of shareholders (which should preclude management from blowing "surplus" cash on fancy office renovations and the like, but query whether it does). But simply holding cash (even if shareholders might be able to find a better use for it) isn't likely to be in violation of that duty since it isn't obviously contrary to shareholder interest as shareholders in the company.

[rp1]

Carney should be reading "Ultra Easy Monetary Policy and the Law of Unintended Consequences" by William White.

http://dallasfed.org/assets/documents/institute/wpapers/2012/0126.pdf

He should have raised the damn interest rates already. Instead, we have allowed imbalances and risks in the domestic economy to grow. There is more unproductive debt than ever and more bad investments. Yeah sure the economy is chugging along. That's because Canadians are plowing more and more borrowed money into real estate at prices that make ever less sense. Do you know how many families I know that are "broke" with two properties? They are bad investments. But people are still eating from the trough because the debt is subsidized. They aren't thinking. Why?

Carney and Flaherty have smothered market signals with easy credit. There were no repercussions for this behaviour last time, no reckoning, just more subsidies and speculative mania. This is the Austrian line of thinking where you need a recession to clear out malinvestments, reward prudence with opportunities, and keep everyone else sharp. Their solution in 2008 was to prop everything up and extend the boom with bloated debt. Just like Alan Greenspan in the early 2000's. I'm afraid the consequences of this will be extraordinarily severe. As our economy has become much more dependent on this, and a similar malinvestment bubble in China that has produced entire empty cities, we have squeezed the hell out of everyone else through inflation.

There is really nothing to say at this point, except that I am diversifying out of Canada totally. There will be a consumer debt crisis, followed by a government deficit crisis where the social safety net will be slashed to ribbons. I do not understand how people can not see this. Most of this "financing" is not growth, is it simply pulling forward demand at grossly inflated prices:

http://www.theeconomicanalyst.com/sites/default/files/u3/gdp_from_housing.png
http://www.theeconomicanalyst.com/sites/default/files/u3/percent_labour_force_employed_in_construction-_can_vs_us_0.png
http://tinyurl.com/9xy3g2q
http://tinyurl.com/8s4a3kg

Financing real estate, which is now a massive part of the economy, *doesn't increase income* because renting is much cheaper than buying. In fact, all of this borrowing is making us poorer because you have to pay for financing! But the demand is felt right now, and the construction income is earned now, but in the medium term it is easy to say that the standard of living for Canadians is going deep into the toilet with a flush. The only thing sustaining this credit-based ponzi scheme now is the widespread belief that these gross imbalances nurtured by Flaherty and Carney will continue to grow.

For Carney it is a job well done if he isn't blamed, and for Stephen Harper it is "mission accomplished." For Canadians it is "how could you possibly not recognize recent economic history?" The more I think about it, the more I think we deserve what is coming to us. Except that the cost is certain to fall on the innocent and not on those most responsible for this outrage.

[rp1]

So yeah, Canadian companies are responding rationally to massive uncertainty caused by massive imbalances in the Canadian economy and in global economy.

[Patrick]

Bob, I didn't say they had a duty to pay dividends, period. I said management should pay dividends if they "hold cash for no other reason than they have no idea what to do with it". The assumption being that if management doesn't know what to do with it, it's probably in shareholders interest to give them their money. I really can't imagine that this should be at all controversial. Especially to righties.

[Determinant]

It's not controversial to me and I'm a lefty. If management cannot find internal investments for the cash and cannot see any acquisition or expansion that will be profitable and agree with their business model, it belongs in the hands of shareholders who can then redirect it into consumption or additional investment in a third party.

That's supposed to be Basic Capitalism but it's a part modern corporations seem to fall down on by making silly investments in unrelated businesses or blowing it on compensation.

[Mike Moffatt]

Why are we assuming that corps "don't know what to do with the cash"? Is there any evidence for this position?

Holding cash is not evidence, by itself, of a lack of a plan as illustrated by my earlier example.

[Mike Moffatt]

"Flush cash accounts indicates a financial capacity to spend."

Sure, but it seems that you're assuming that cash and spending are substitutes. They aren't necessarily, as my example suggests.

[Mike Moffatt]

"It seems to me I've seen int'l studies ranking mgnt by country. Not sure what criteria they use. But as I recall, Canadian mgrs don't even come in the top 10."

Agreed. But what does that have to do with "holding cash"?

[Jacques René Giguère]

And given that these rankings are un- and ascientific fr"/$$%ng bs, what is the relevance anyway?

[Mike Moffatt]

"Have you read the reports I linked to?"

Yes. Several times, in fact. I am not unfamiliar with them.

[Mike Moffatt]

We're confusing *how* investment decisions are made with how they're financed. We shouldn't do that:

Fisher separation theorem.

Again, what does any of this have to do with the *specific* problem of "firms holding too much cash"?

[Mike Moffatt]

"So, do you agree with their findings?"

Mostly, but that's irrelevant. I also think that Earl Weaver was the greatest manager in baseball history. I think abolishing the penny was a good idea. I think Han shot first. But what does any of that have to do with corporations holding too much cash?

"No, I think you are implicitly suggesting that when Carney made the reference to holding increased cash, he had not also been monitoring levels of investment."

I'm not assuming anything about Carney. I'm specifically talking about this idea that corporations are holding too much cash.

"It can't be through lack of cash."

Sure, but who was making that argument? Such an argument would also be silly, as per Fisher.

[Patrick]

I admit that I haven't looked at Carney's statement closely. It may be that he has been taken out of context or is just wrong. I'm inclined to give him the benefit of the doubt. And I won't hesitate to admit that I'm also disinclined to give management, as a group, the benefit of the doubt.

[Mike Moffatt]

If considering the Fisher separation theorem and not wanting to conflate two completely separate economic phenomena is "being anal", then guilty as charged.

[Mike Moffatt]

I'm not sure how many times I need to state this - I'm addressing the argument (much of which has progressed beyond what Carney said), not the man.

[Patrick]

Mike, what would you consider evidence (or an argument) that a firm is holding too much cash?

I'm kinda making a simple and perhaps unsophisticated argument and just asserting that if management doesn't have a clear plan to put surplus cash to work pursuing the usual objectives of the firm, then they ought to give it back to shareholders. What's wrong with this?

[Bob Smith]

Patrick, I don't think there's anything wrong with your argument, if true. It's just that we have no way of assessing the truth of it. There are good reasons for holding cash (liquidity) and bad reasons (management feather bedding, though that seems like an implausible explanation for the magnitude of current cash holdings). If true that cash holdings of a particular company are excessive or being used for inappropriate purposes that's something that shareholders (particularly large institutional shareholders) and would-be acquirers are quite capable of assessing on their own, and certainly they are better situated to assess that than either of Misters Carney or Flaherty.

Moreover, as Peter Foster pointed out, the focus on "cash" is misleading because it doesn't look at the totality of the corporate balance sheet. It's true that, if you look at the statscan balance sheets for non-financial industries, cash holdings have increased significantly between Q1 2008 and Q1 2012, from $184 billion to $280 billion (a 52% increase). That looks damning. But then step back and look at the broader balance sheet. Over the same period, total assets have increased from $2.94 billion to $3.65 billion. Cash remain a tiny portion of total corporate assets (7.67% compared to 6.12% 4 years ago).

Furthermore, dig down into those number and other look at what has happened to other short-term assets that a company might hold, say, accounts receivable. 4 years ago, accounts receivable accounted for 11.78% of total corporate assets, now they only account for 10.67% of total corporate assets. To the extent that cash is up and accounts receivable down that might reflect either tigher credit terms on the part of Canadian companies (possible a prudent strategy in the face of uncertainty) or else greater dedication to collecting amounts owing. In either case, that's not obviously a sign of bad management (possibly the contrary) nor is it evidence of cash holdings - it reflects a decision on the part of corporations to hold cash over accounts receivable.

Finally, and to Mike's point, looking at corporate balance sheets, you're struck by the fact that assets as a whole have increased by 30%, and net capital assets have increased by 27%. By focusing on cash holdings, Carney and co. are losing the forest for the trees.

Anyhow, judge for yourself.

Q1 2008 Statistics

Q1 2012 Statistics

[Mike Moffatt]

"I'm kinda making a simple and perhaps unsophisticated argument and just asserting that if management doesn't have a clear plan to put surplus cash to work pursuing the usual objectives of the firm"

Who says they don't have a plan, though?

For example: Whenever I get loose change, I put it in one of those empty 18L water jugs. Every year I take that money and spend it buying gifts for Christmas. If I don't spend that this afternoon, does it mean I don't have a plan?

[Mike Moffatt]

In other words, what's wrong with your statement is it assumes facts not in evidence.

[Bob Smith]

AB,

Fair enough, but it's surely a poor critique that my back-of-the-envelope analysis over my cofee break isn't up to snuff. In any event I note that's a their data seesm to includes the financial sector) without the benefit of the broader context. Of course, if I had the time or the inclination, I could go through the sector specific data contained in the same statscan publications that I linked to.

Does Finance or the Bank of Canada have access to data I don't, undoubtedly. Have they used that data to provide a basis for Mark Carney's off-the-cuff comments? Well, there's no evidence of that (indeed, the fact that the comments were off-the-cuff would suggest otherwise). More to the point, institutional investors and private equity fund manager also have access to data that I don't have, and unlike the Bank of Canada and the Department of Finance, a vested interest in applying it to assess the competence of corporate management. Until I see them hooting and hollering about excess cash holdings (or taking over Canadian companies en masse) I'm not inclined to see "excess" cash holdings as a problem.

[Bob Smith]

Sorry, I cut a part of the second sentence:
"In any event that's a critique that a critique that applies equally to the Flaherty/Carney criticism based on the self-same cash data (worse, in some respects, since their data seems to includes the financial sector) without the benefit of the broader context."

[Patrick]

Mike, Whoa there Tex! I'm not arguing here. It's you against Mark Carney. I get your point, but why do you think you he might have said what he did? I can believe that Flaherty would talk sh*t, but the Governor of the Bank of Canada? Not so much.

[Patrick]

If you dig into the stats Bob provided, they give sector breakdowns.

If you go back to e.g. 2005 and compare,cash as a percentage of total assets (which may or may not make sense, I dunno), it has has gone-up quite a bit. I suppose that could be the stock market at work - I have no idea. Total assets seem to be much smaller today then back in 2005 (in nominal terms too ... odd).

How does mark to market accounting affect net capital assets? Could something like FASB 142 be distorting the picture?

[Bob Smith]

"Let's keep in mind that he was responding, in a general way, to a question posed to him from a reporter. The reporter was referring to a study embedded in a CAW report (see link to video clip provided earlier)."

Exactly my point, there's no evidence of an in-depth study on the point by either the BoC or Finance - as you note, he was responsing to a CAW report.

" In his reply, he suggested that he would expect to see more pressure being exerted by shareholders if this is a real issue for a given firm, and persists. So would I."

So would I. But I haven't seen it.

[Bob Smith]

I'm sure they do. I doubt they do sector-by-sector analysis of the appropriateness of corporate cash holdings, since that requires a firm level analysis.

[Bob Smith]

It's not the consolidation that's the tricky part - statscan does that - it's the assessment.

[Bob Smith]

Looks like National Bank Financial has done some analysis along those lines on a company by company basis (story">From the Post). I haven't been able to find the report, but looking at some of the big name cash holders (either in terms of relative or absolute cash holders), I'm struck by the fact that these are companies who have pretty real liquidity concerns (RIM, Air Canada) or else are in cyclical industries where hefty cash holdings might help ride out market downturns (Teck, Hudbay).

They do note that some of those companies could distribute cash to their investors but I note that a number of them are companies that have been raisings funds recently through private and public offerings - notably the many REITS such as RIOCAN - so they clearly have some use for that cash in mind (and, in the case of the REITS, because of the demand for yield out there in the market, the cost of raising capital is probably at a record low).

[Bob Smith]

In terms of the different numbers people are looking at different thinks. The CAW is looking at the national balance sheet accounts which includes both public and private corporations (and I suspect things like business trusts, but can't confirm that) and governmment enterprises (which probably shouldn't be included in this discussion). Frankly, private corporations probably shouldn't be included in this discussion either, since if their owners want to get cash out of the company to put it to some better use, they can usually do so. The numbers I was using came from a different statscan balance sheet (although I think their broadly consistent with what the CAW uses).

NBF is obviously using a subset of the 4000 odd companies listed on the TSX, hey no one has sufficient data to assess the adequateness of a all companies cash holdings (since such an assessment requires company specific data). But it isn't clear that the subset they're looking at would differ in their predilection for "cash hoarding" (to use the pejorative) than other public companies. In any event, its a more qualitative analysis than the bald assertions of the CAW that $500+ billion in cash is too much. And for what it's worth, I think they did look back over the past decade and concluded that the cash holdings wasn't out of line with the average for TSX listed companies over that period (that was in the post article, but not the globe - sorry about the link, here it is again http://business.financialpost.com/2012/09/05/minimal-evidence-that-canadian-companies-are-hoarding-cash-nbf/)

In terms of international comparisons, hey, it's a fair point, but since no one is making that comparison, it goes both ways.

Also, it's worth taking another look at the balance sheet figures that the CAW is drawing on. They highlight the sharp rise in cash holdings since 2008, but what's remarkable is the equally sharp drop in holdings of short-term paper, falling from $310 billion in 2008 to a little over $200 billion in 2011. Since cash and commercial paper are close substitutes you wonder if the purported "cash hoarding" doesn't just reflect, in part, a shift between short-term asset classes. If companies prefer to hold bank deposits than commercial paper, one isn't an obviously "deader" form of capital than the other.