The Clover Helix
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Monday, October 24, 2011
The economy is in the trash, government budget deficits are exploding, and unemployment is at multi-decade highs. This isn't some doomsday scenario, this is today's realty in America. All the while, America's biggest corporations, as represented by the S&P 500, are "hoarding" over $1.6 trillion and are "refusing" to hire new workers. The fix? Find a way to force these corporations to dishoard these huge balances and get them to allocate it to hiring workers. New workers will buy goods and pay taxes, which in turn will reduce the budget deficit and promote even more hiring and economic growth. That's the theory at least, but is it correct? The answer may surprise you.
It is the primary duty of businesses to operate in the best interest of their investors and to treat their profits accordingly. In some cases, a business may elect to pay out the accumulated profits in the form of dividends. However, dividends are taxed at both the corporate and individual level resulting in an insidious double tax that is born by the shareholder. To avoid this double tax, a business may choose to hold onto its profits and reinvest them back into itself. In this manner the shareholder may benefit via a higher stock price that, when sold, are taxed at more favorable capital gain tax rates. It is not surprising then that even the largest dividend paying firms will still hold onto some of their profits for future expansion. During an expanding economy, this profit reinvestment fuels their growing workforces in an effort to compete in the global market. However, during a period of economic contraction like we are currently experiencing, businesses are more likely to avoid hiring in anticipation of lower future profitability. Lower profitability makes it harder for a company to increase its share price or borrow money to fund expansion. If these businesses don't distribute large dividends, then the profits are held on the corporate balance sheet in a defensive manner until economic conditions improve. This is what most annoys almost all Keynesian economists, that the cost of corporate "hoarding" appears to be born by the growing ranks of the unemployed. The typical Keynesian solution is to use government spending to bridge the hole left by these "hoarders" which is why they argue for increased budget deficits to get us out of the economic rut. But is this the fault of private sector?
The question that Keynesians have failed to ask is what actually happened to the money the corporations were "hoarding". Keeping hundreds of millions, even billions, of dollars in physical cash and coins in a hidden vault at the corporate headquarters is what hoarding would truly be, but this is never observed because management of this vault would be monumental. Rather, most people would guess that they keep that money on deposit at a major bank. In truth, most major firms would avoid doing this with the bulk of their money because bank deposits are only guaranteed by the FDIC up to $250,000. If a bank fails, then companies that have very large deposits with them could also be wiped out (this is called counter-party risk). Therefore, most large corporations do not hold their money in bank deposits. If banks aren't safe for giant deposits and they don't hold physical cash, then where else would they put this "hoarded" money? The answer: risk-free government treasury bonds and short-term money markets backed by government guarantees (i.e. the Treasury Department's printing press).
So the money isn't being hoarded at all, rather it's been used to service the expansion and rolling over of government debt (which explains Paul Krugman's problem of why interest rates can be so low while the government continues to spend in unprecedented amounts). When corporations (or individuals for that matter) buy government debt, they are transferring their money to the U.S. Treasury in return for government IOUs. These bonds can have either very short maturity dates or be sold by the companies again to raise cash when the economy recovers. In the mean time the "hoarded" money is left in the government's hands. This helps the government in two obvious ways. First, it lowers interest rates so the government bears a lower interest cost. Secondly, it provides the government with money to spend on government programs and stimulus. However, the ability of the government to borrow money and stimulate the economy has been dealt with in a previous article (click here). In effect, the "hoarded" money has been transferred to those who would most desire to see it used for government spending, therefore the problem of growing unemployment lies with the government and their economists, not with the corporations who are waiting for the economy to settle before they jump back in.
This high unemployment rate is therefore a failure of government, not of free markets. Exploding deficits won't help and neither will taxing the rich who have already lent almost all of their money to the government. That the answer lies in reducing government debt to cure the economy may seem counter-intuitiuve, but that's exactly what the government did to stop the Depression of 1920-1921 which was much deeper and harsher than the current economic slump, but also lasted only 18 months. In the absence of a government bond market, corporations are forced to allocate their capital to the productive portion of the economy which brings about research, development, and larger workforces.
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