Of Ants and Grasshoppers
In the classic Aesop fable “The Ants and the Grasshopper,” the former are virtuous, exercising vision, thrift and restraint, while the latter exemplifies shortsighted indulgence. But now, when thrifty ants are generally in short supply, the high rate of saving by businesses has become a concern to many economic observers.
In October, for example, the Wall Street Journal ran a front-page story (“Despite Piles of Cash, Businesses Get Stingy About Spending”) noting that “…while hiring and investment have risen, American business is proving reluctant to move very aggressively, perhaps unsure about the economy’s direction or the Iraq war and the threat of terror.” This view was echoed by San Francisco Fed President Janet Yellen: Recognizing that business investment “…has been strong, it is probably less strong than one might expect, given the highly favorable fundamentals.’” Her diagnosis? “This suggests a continuation of the caution that has marked business decision-making in the wake of terrorist threats and the issues surrounding corporate governance.”
With all due respect, however, this interpretation seems off base. Rather, today’s high saving behavior by businesses should provide comfort, rather than concern, about the economy’s prospects.
Before explaining why, let’s acknowledge the scale of the issue. Cash holdings at nonfinancial corporations stood at 22% of output during last year’s third quarter – higher than anytime in decades and up sharply from 18% as recently as the 2000-2001 period. With that sector’s output running around $6 trillion, that 4-point gain represents $240 billion – a tidy reserve indeed.
But attributing this horde to executive wariness doesn’t jive with opinion survey research. The Conference Board, for example, reported that 62% of executives surveyed during the third quarter were upbeat about prospects six months ahead – a high reading by any standard. At the same time, the National Federation of Independent Business reported that its Index of Small Business Optimism averaged a lofty 104.4, before heading to what is likely to be a record high during the fourth quarter (based on October/November results).
If not low confidence, then what might explain the stockpiling of cash? To our friends, the ants, the answer is obvious: Businesses were conserving their resources during times of plenty so they may be enjoyed during the leaner times to come. You see, federal tax policies towards business investment became extraordinarily – and temporarily – generous during the 2002-2004 period. One aspect alone – the “depreciation bonus” – allowed for accelerated depreciation is a zero-sum game (i.e. the more depreciated today, the less may be depreciated tomorrow), and since those tax breaks are now over, the leaner times have arrived.
And so this stockpile of cash is one reason, among others, that business investment will remain strong this year despite the disappearance of temporary tax benefits. Or to quote Aesop, businesses are well prepared for “spending a fine winter’s day drying grain collected in the summertime.”
