Central bankers save the day – again
Once again, monetary policy has saved the day. In the Eurozone, the ECB’s Long-Term Repo Operations have staved off a banking crisis and given the beleaguered sovereign debt markets a powerful shot in the arm. In the US, QE2 has helped turn investor sentiment around and rekindled business and consumer confidence, allowing the US economy to move ahead after the slowdown last autumn. The UK seems to have avoided a double-dip recession, but its economy continues to bump along the bottom and ITEM forecasts growth of just 0.4% this year.

The reasons for this dismal picture are obvious and inescapable. As a nation we have been living beyond our means and need to adjust. Austerity is the word of the day, not only in the UK but also our major European export markets. Banks are not re-capitalising sufficiently quickly but are responding to higher capital requirements by reducing their balance sheets.

Large industrial corporations are accumulating cash…
However, there is one part of the economy that has not been living beyond its means. The corporate sector is accumulating cash at an astonishing and accelerating pace and acting as a major drag on the rest of the economy, keeping it close to stall speed. It is hard to see any strong revival in the economy until companies start to release this cash by spending more on acquisitions, investment or dividends.

It is interesting to take a look at the current conjuncture from a cash-flow perspective. The chart above shows the net amounts earned or spent by each of the main sectors of the economy in the last two years. Ideally each would be close to zero. What stands out is the government financial deficit or net borrowing, which pumped £147 billion into the economy in 2010 and a further £122 billion last year. But these massive figures were largely the consequence of cash being drained out of the economy and indeed the Exchequer by the private sector. The biggest drain was the company sector, which sucked a hefty £72 billion out of the system in 2010, and a further £80 billion last year. And most of this cash is being hoarded, not spent or invested. Non-financial companies increased their holdings of currency and bank deposits by £48 billion in 2010 and a further £82 billion last year, taking the total to £754 billion, a staggering 50% of GDP.

It is not difficult to see how companies find themselves in this cash-rich position. Globalisation has dramatically increased the power of capital over labour, with workers at the bottom of the pile and even the ‘squeezed middle’ coming under huge pressure. This has been most apparent in the US where companies continued to post record profits right through the downturn. In the UK, companies have been swimming in cash while consumers have been drowning in debt.

…but they’re not investing
Economic forecasters at the Office for Budget Responsibility (OBR), the ITEM Club and elsewhere assumed that larger companies would soon spend much of this accumulating cash on investment. After all, it was very hard to justify putting funds into risky bank deposits with a return of less than 1% when investment spending had in many cases been pared back to a care-and-maintenance level during the recession. However, forecasters’ expectations were not realised. While business spending has been very buoyant in the US, there has been no resurgence in the UK and judging by the investment intentions surveys there will be very little revival this year. Corporates cite lack of demand, volatility and unrealistic vendor expectations as reasons not to invest. The question is when this view will change – it may well be that corporate decision criteria are now out-of-date and don’t reflect the new market environment.