By Ajit Ranade
Next week will be a nail-biting finish to the “game of chicken”, or who blinks first standoff between the US president and the opposition Republicans. If they don’t reach a deal before the deadline, the stalemate will lead to a historic default by the US government. Washington has been wrangling for months to avoid this catastrophic outcome. The current debt ceiling, also called overdraft facility available to the US Treasury Department, is about $14.2 trillion. During the previous presidency of George W Bush this ceiling was raised seven times to $11.3 trillion. Over the entire Clinton presidency it was raised only once. Unlike anyone before or after him, the Clinton regime enjoyed a fiscal surplus in its last couple of years. The post 9/11 scenario, followed by two wars and tax cuts, quickly transformed a fiscal surplus to a yawning deficit. This was coupled with record trade deficits too. And then there was Lehman and a huge fiscal push. The national public debt ceiling currently stands slightly above 100 per cent of GDP. This ceiling has only gone up, never down. Raising the overdraft limit requires legislative approval, but has often passed off routinely. But this time, the game of chicken and bitter partisanship has rattled financial markets. You may wonder, why doesn’t President Obama simply authorise airlifting of some gold to Switzerland for an emergency overdraft!
Just like the deadlock in Washington, on the yonder side of the Atlantic is the Euro-angst over a fiscal crisis that has spread like wild fire from country to country. In Europe too there is continuous squabbling over who should bear how much of the Greek and other countries’ fiscal burdens. Despite great austerity, pension cuts, asset fire sales and privatisation, the foreseeable future is a sea of red ink, for Greece and its ilk.
Now contrast this what is happening in the corporate sector. The strength of economic growth in Germany is astounding. The monthly industrial production numbers look almost China-like. In America, corporate profits have been expanding for 10 consecutive quarters. The share of corporate profits in national income is close to 13 per cent, above the pre-crisis level of 2007, and closing in on all time high. Apple beat analysts’ expectations by a wide margin this quarter. This year it is going to be a $100 billion company with 30 per cent profits. It has zero debt, and its market value is likely to overtake Exxon! Of course, Apple is unique and iconic, and not at all representative of the entire corporate sector. However, many other firms too have beaten profit expectations.
But what is truly stunning is the cash holdings of all corporations. Apple alone has $72 billion in cash or cash equivalents, more than the annual GDP of half the countries in the world. Microsoft and Google together have more than $100 billion in cash. The estimated cash and equivalents of US corporations is excess of $2 trillion, equal to the entire foreign exchange reserves of China. Except that the former is more liquid, since the latter is stored mostly as debt of America, whose ceiling might have to be busted next week. The proportion of cash in the assets of all non-financial firms in the US is also at record high. The uncertainty caused by fiscal crises, high volatility of commodity prices, high incidence of inflation in the growth markets, and relatively high valuation of assets, is causing corporations to hoard cash, and postpone capital spending. This is in sharp contrast to the capex frenzy seen in the mid to late 1990s. Since cash holders are postponing capex decisions, the futures markets appear unusually upbeat with high price signals. But the cash hoarding is a perverse sort of liquidity trap à la Keynes. Why don’t they simply return the cash to the shareholders?
The rosy picture of corporate profitability is in sharp contrast to the grim news on unemployment and wages. Income inequality has steadily worsened. Returns to labour (that is, wages) stagnated for almost three decades, while returns to capital, especially finance capital, soared. Consumers of course had access to both forms of incomes, either through the stock market or home equity. But the richer folks had a higher share of capital income than labour income. The growth in sub-prime home mortgages masked some of the income inequality, but that mask is now off, thanks to Lehman and its aftermath. The China story is similar. High economic growth for three decades did not lead to any improvement in real wages (except maybe the last two years). Consequently, the profit share of corporations (mostly state owned) grew tremendously, which in turn fueled more investment and capital spending. But due to stagnant wages, and low access to stock and housing markets unlike the US, consumer spending as a share of GDP fell throughout these past three decades.
One obvious explanation, not without some merit, is that the pile of corporate cash is nothing but material that came from deep fiscal hole of governments. That is profitability sustained on steroids called QE1 and QE2 (and similar others in other countries). Since investment confidence is still lacking, that nervous cash is not being deployed. Perhaps a QE3 injection may be required.
As always the Indian story is quite different. The fisc here is also in a mess, but not because of a huge fiscal stimulus given to tide over Lehman. It is mostly because of high oil prices, which lead directly to fuel and fertiliser subsidies. One-third of the federal budget in India goes to interest payment, and another fourth to subsidies. This is counting the compensation to oil companies for “under recoveries”, a peculiarly Indian term. In the coming months another 10 per cent of the budget may become earmarked, thanks to the proposed Right to Food. The deficit is unlikely to dent investment optimism, which is currently only at a cyclical low point. Hence corporate cash hoarding is a lower risk in India than elsewhere.
While we wait for Washington to untangle its fiscal knot, and US corporations to begin a new capex spending cycle, here’s an Asian dramatic idea. Chinese cash for India’s infrastructure?
The author is chief economist, Aditya Birla Group. Views expressed are personal