August 30, 2012 – In today’s Financial Post, MLI’s Philip Cross responds to the recent remarks made by Bank of Canada Governor Mark Carney on how corporations should either spend their ample financial reserves or return the value to shareholders through buy-backs.
According to Cross, “It is the job of companies to make money for their shareholders, not to put money to work.” He adds, “Corporate savings are not “dead money” where dollar bills are just rotting in bank vaults. This money is actively being loaned out, as just noted, to governments and households. More fundamentally, companies that save money are buying something — financial security, an important if intangible asset in a world full of risk and uncertainty.”
Cross says that Carney’s comments leave the mistaken impression that firms are doing nothing with their profits. “Firms have increased investment over the course of the recovery at a steady rate, averaging 10% a year to return to their pre-recession level,” he said. “The 14% increase last year was the best annual performance since 1997.”
The full column is below:
Why Carney is wrong and ‘dead money’ is just fine
By Philip Cross, Financial Post, August 30, 2012
Bank of Canada Governor Mark Carney took a break last week from apologizing for illustrating the $100 bill with an Asian woman (I told you an oilsands plant was the way to go, Mark) to castigate corporations in Canada for their high levels of savings, saying firms should either spend their ample financial reserves or return the value to shareholders through buy-backs.
Not surprisingly, business leaders did not react well to being lectured by a mandarin in Ottawa on how to run their businesses.
There are several problems with Carney’s analysis. First, why single out firms in Canada for high savings rates? It is well known that firms around the world, beginning around 2001, started to save at a consistently high rate. It is a conundrum that has befuddled economists for years, but the point is that Canadian firms are no different than most in the OECD outside of the U.S. (where firms joined the rest of society in gorging on debt for much of the past decade). In particular, firms in Germany, the UK and Japan regularly have had higher savings rates than in Canada over the past decade, but their central banks don’t take them to task for being prudent.
More corporate saving proved propitious during the 2008 financial crisis and its aftermath. It cannot be lost on business leaders that Ford, with large cash reserves and a timely line of credit, survived the recession, while GM and Chrysler went bankrupt. The recession underscored that firms in cyclical industries require good balance sheets in a climate where they don’t know if their market will collapse tomorrow or if their friendly local banker will even be solvent.
Not surprisingly, firms throughout the OECD have further increased their savings rates after the bloodbath of the recession, except those in Canada, where corporate saving rates remain below their pre-crisis highs. Much of this saving originates in industries that are highly cyclical, notably the resource sector, transportation and of course the financial sector itself, the latter responding to the calls of bank regulators (notably Carney) to increase their reserves of cash.
The Bank of Canada talks incessantly about the strong headwinds of uncertainty the global economy faces, especially in Europe. At home, elections that may change royalty policies for key sectors like mining are around the corner in Quebec, B.C. and probably Ontario, and just concluded in Alberta. So don’t be surprised then if firms hoard cash in such an environment of uncertainty. Firms, unlike the Bank, have their skin in the game.
Economists understand that, in aggregate, net borrowing must equal net lending. At the peak of the crisis in 2009, the Bank was content to see the government deficit balloon to fight recession, and encouraged households to borrow with record low interest rates. If households and governments are net borrowers, inevitably firms must be net lenders, which require savings. The only other possible source of funds is non-residents, who could not finance all government and household borrowing despite Canada’s growing reputation as a safe haven.
Calling corporate savings “dead money,” Carney said that “their job is to put money to work.” No, it is the job of companies to make money for their shareholders, given the constraints of the macroeconomic environment, not to put money to work. Moreover, corporate savings are not “dead money” where dollar bills are just rotting in bank vaults. This money is actively being loaned out, as just noted, to governments and households. More fundamentally, companies that save money are buying something — financial security, an important if intangible asset in a world full of risk and uncertainty.
Finally, Carney’s remarks leave the mistaken impression that firms are doing nothing with their profits. Firms have increased investment over the course of the recovery at a steady rate, averaging 10% a year to return to their pre-recession level. The 14% increase last year was the best annual performance since 1997. Not exactly sitting on one’s hands. Exports are the one sector of the economy that has not recovered completely, as the global economy struggles, so maybe that is where Carney can help the most.
Carney’s comments were off the cuff, after the first speech by a Bank of Canada governor to a labour organization, the CAW. Hopefully, his remarks only reflect the temporary exposure to the crackpot economic thinking that permeates the walls of the CAW, and not official Bank policy. If it is the latter, start saving more. By the truckload. Maybe in an account in the Cayman Islands.
Philip Cross is the Research Co-ordinator at the Macdonald-Laurier Institute.