3 Dec 2012

Why are we holding back?

On the FundWeb page Tomas Hirst has posted an article about the problem of reserves. Corporates Sitting on Piles of Cash. The strap line is
"When the UK corporate sector reacted to the onset of the financial crisis by hoarding cash reserves, it set in train a phenomenon that is now casting long shadows over the UK recovery."
As he says a report has put the cash reserves at £729bn. To put this in perspective the total private debt in the UK is £7.4 trillion. So the cash reserves are about 10% of the total debt. He then goes on to outline the problems caused by lack of business investment - based on various other reports. But none of these reports are able to see that lack of business investment is also a problem with a cause - massive private debt.

I tried to post a comment on the website but it kept self-borking, so I'm putting it here instead. (Always write long comments in Notepad before posting them!)

There is certainly some evidence to suggest that business is sitting on reserves. But there is also evidence (from the 2011 Budget Report and a subsequent McKinsey Report) that private debt in this country is around 490% of GDP, and McKinsey thought this on the increase at the end of 2011.

Now I've asked every economist I come across the same question: what are the interest payments on ~ £7 trillion of debt likely to be? They uniformly ignore me, even the one's that argue that we should be looking at private debt.

We can see that every 1% of interest rate requires about 5% of GDP. But what is the average interest rate? 1% 5% 10% 20%? No one seems to know or care.

In an economy where interest payments alone amount to a significant proportion of GDP (my guess is about 50% each year) we don't have to theorise why demand is low. It's because everyone is busy deleveraging (including the finance sector who account for about half the total debt). As Richard Koo observed: right now business is not maximising profit, it's minimising debt.

But what it also means is that investing right now is not going to produce much return because the choke is on demand not supply. People are simply buying the absolute minimum of stuff at every level of the economy. More supply of anything in an economy saturated with debt is not going to stimulate much in the way of demand. At the same time government is busy squeezing the economy - and undermining confidence. And meanwhile we know that 1000's of zombie companies are being kept afloat by the banks in the hope that things will improve soon. But even the one-eyed, head-in-the-sand government are starting to realise that a recovery is a long way off. Those zombie companies are going to be wound up soon - let's see how Christmas goes...

So what would a sensible individual or business do with their reserves right now? Buy gold? I don't know. But investing in a new business venture would not be sensible right now in general. Of course some people are doing it and doing well. But they are a drop in the £1.5 trillion GDP bucket. And the Bank of Dave is happily and profitably lending money. But a few thousand at a time.

Those reserves could be quite huge, but until the debt problem is sorted, which will take another 10-15 years, there won't be much incentive to make risky investments.

I don't disagree that there might be reserves, and they'd be better spent than not. But in the broader perspective it's not sensible to risk your capital in business ventures right now. Which is partly why banks are loathe to lend - they've sobered up and realised that, given their reserves, they loaned far too much money at far to high a risk, in the 1990s and early 2000s. And now it's being said that they're under-capitalised - which is arse about face.

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Keep is seemly & on-topic. Thanks.