Corporate Saving is Killing Our Economy – But CEO’s are Making the Numbers
I read with great interest a Comment in today’s US print edition of the Financial Times. It is by Martin Wolf and it is titled, The corporate contribution to the savings glut. This fascinating article highlights a condition that is both worrying and troublesome. The article explores the fact that corporations have been, since around 2000, saving more than they have been investing. This is worrying in that this behavior goes some way to explain the low investment levels that are contributing to low productivity, which in term explains to some degree our low wage growth. This behavior is troublesome in that corporate executives seem quite happy to “carry on and save” since they are quite able to meet their goals and objectives. In truth current low interest rates are funding cheap loans to provide the cash firms need to buy-back their stock, thus driving up earnings per share (EPS) which helps CEO’s and boards to meet their bonus targets.
The article does not complete the circle – it focuses on the savings cycle and the lack of return firms must experience from use of those savings. It does not look at how firms and their bosses are still able to meet their goals – I added that. But I think the two elements are connected and it has created a cycle we are not able to get out of. And the cycle – leading to low interest rates – is throttling the rest of the economy. Let’s start with short term goals of firms over long term strategies.
CEO’s and boards of public companies desire to meet the goals of their stakeholders and this tends to result in a need for long term investment to help drive innovation and change. This is a risky business to be in but it is what makes winning in business so much fun. However, due to the financial crisis and economic recession that followed, interest rates were abnormally low. This permitted some enterprising CEO’s to take out cheap loans to fund M&A (even though share prices are relatively high at present) but also fund share buy-back deals.
The share buy-back deals have the effect of reducing the number of shares of a particular stock in the market and so pushing the EPS up. If you can reduce the number of shares outstanding faster than your earnings decline, your EPS still goes up. EPS is in fact one of the main triggers for bonus awards for senior executives. EPS was a reasonable proxy for measuring effective investments that payed off and has worked in the past. At this point, the “how ” the EPS improvement is being achieved is not being measured. So the result is that with high valuations, low interest rates, easy access to cash, improving EPS, firms find less and less need to take risky long term bets on investment to fund future EPS growth, when they can get easy pickings shorter term. The result: a corporate savings glut.
The net net is that interest rates are kept low for even longer. This then reinforces cheap loans, and otherwise depresses other parts of the economy, this driving central banks to printing and spending even more money (QE) pumping up the stock markets around the world – as if that really makes us all more wealthy. We are now in a trap and we can see no sign of getting out. When the US Fed last messaged the first attempt to raise interest rates, the market had a “taper tantrum”. Now, better prepared, the US Fed and stock market might actually safely move rates higher without any childish screaming. But at the same time the US is thinking to tighten monetary policy, we have Europe and Japan talking of more easing; and emerging markets already hit with collapsing commodity prices about to be hit by massive withdrawal of investment toward more attractive US options. Thus the Fed may have to hold fast, until better days. But those better days are not looking like they will come about due to the entrepreneurial nature of the American CEO.