Global Trend

The World Is Swimming in Cash

An old saying tells us, “You can never be too thin or too rich.” But the truth is that you can have too much cash. Today, the developing world and Europe are spending less money than they are taking in, and the result is a surplus of savings that the global economy must somehow learn to use effectively.

We can identify at least five sub-trends that have contributed to this situation:

1. Corporation in Japan are making more money than ever before, but they’re not spending it.
2. The Chinese are spending money ? they’re buying up companies and other assets, especially in the U.S. and Canada ? but so much money is pouring into that country that they simply can’t get rid of it fast enough. Much of it is sitting in short-term debt instruments and U.S. Treasury bonds.
3. High oil prices are filling the cash coffers in Russia and the Middle East, even as instability in those oil-producing nations stifles new investment of those riches.
4. Aging European workers are socking their savings away in anticipation of their own retirement and an uncertain future. Unfortunately, slow growth in Europe makes investing there problematic.
5. Even in the U.S., where the personal savings rate is below 1 percent, rising corporate profits have added $634 billion to company cash hoards in the past 12 months.1 This is double the accumulation rate of two years ago. Companies that make up the S&P 500 stock index now hold cash equal to nearly 8 percent of their own market capitalization ? twice the ratio in 2000. One-third of all the non-financial S&P 500 companies have more cash than debt, twice the ratio observed just five years ago. This corporate cash has pushed our national savings rate to nearly 15 percent. In other words, we have gone from the problem of too much debt in 2001 and 2002 to too much cash today.

Companies and countries can’t just stuff cash into a mattress. Similarly, banks can’t pay even low interest rates on money that just sits in the vault. Something has to be done with the money. For example, people can spend it on consumer goods, such as cars, clothes, houses, food, and so on. It can be invested in productive assets such as plants & equipment or R&D. Or, it can be lent to others who will spend or invest it.

As the collective result of these sub-trends, short-term interest rates are at 4 percent; 30-year fixed-rate mortgages are below 6 percent; capital investment is on the upswing and stands at more than 16 percent of GDP, higher than it was in the 1990s; and the economy, far from stalling, is entering a boom period. Plus, those low interest rates are helping to build wealth and raise the standard of living throughout the world.

The surplus of cash is a driving force behind a whole raft of important economic trends. Specifically:

- Chinese companies are using the excess funds to buy American assets, as we’ll explain in our discussion of Trend #2.

- The cash surplus is also making an impact on our day-to-day lives by funding the huge housing boom in the U.S., which we’ll explore in Trend #3.

- The glut of cash provides a vast pool of capital for entrepreneurs and corporations that are poised to exploit the fifth wave of the information revolution, as we’ll see in Trend #4.

- It is reshaping the balance of power in the global economy, which is the focus of Trend #5.

- It provides a potential solution to the problem of the nation’s aging infrastructure, because, as we’ll detail in Trend #6, cash-rich private enterprises can invest in new projects like highways, water treatment facilities, and bridges that would traditionally require new taxes.

In addition, access to global savings enables the government to increase health-care spending and wage a war abroad ? all without increasing inflation or interest rates. Foreign savings are being lent to the United States Treasury to fund our deficit, which keeps the value of the dollar high and long-term interest rates very low

But according to a recent article in BusinessWeek, the global economy may be ill-prepared to handle the enormous windfall. All this cheap money is resulting in a spending spree that is causing the price of assets to hit unrealistic levels. That could lead to a bursting bubble. And the global nature of the problem means that the Fed has less power to control it through adjusting U.S. interest rates.

At the same time, it’s made it harder for investors to make wise decisions. Traditionally, U.S. investors made decisions by focusing on what was happening in the U.S. They watched the Fed’s credit-adjusting moves and the budget deficit to predict long-term interest rates. But with the global savings glut, they now need to watch the entire world.

For example, if the Chinese revalue their currency, interest rates here could rise. Why? Because the Chinese would have less of a surplus, and that means they would have less money to invest in U.S. Treasury bonds.

Widespread realization that global savings explain our low interest rates came only this year, after Ben Bernanke, a Federal Reserve Governor, addressed the President’s Council of Economic Advisors in March, introducing the concept of the “global savings glut.”

This realization has raised a level of concern among economic planners, including those at the Fed, because excess global liquidity is an evanescent thing. If investors become nervous, it can vanish. Markets that now run on the assumption of cheap money would have to make major and painful adjustments. In other words, it’s a delicate balance in which any change in inflation, interest rates, or the value of the dollar could have a tumbling domino effect.

Even Fed chairman Alan Greenspan has admitted that we are in “unexplored territory” as far as this new economic order is concerned. The International Monetary Fund tallies the global “savings hoard” at $11 trillion this year, which is nearly the size of the entire U.S. economy. “Savings,” calculated that way, represents all the income in the world, minus all the spending in the world. And it has been growing at an accelerating rate.

Because of demographics, the global savings glut is expected to continue for some time. With money able to flow from country to country unimpeded, it will tend to hold back both consumption and business investment in some countries, while fueling their trade surpluses. So far, this has been a blessing: Last year, the world economy saw its greatest growth in three decades, with modest inflation, amid a cross-border spending spree on corporate acquisitions.

For example, private equity funds are finding it easy to raise billions of dollars to buy corporations around the world. In 2004, they invested $156 billion in European firms alone.

In light of this trend, we offer the following six forecasts for your consideration:

First, in the short term, U.S. companies with high cash surpluses will find it necessary to give back much of their cash to stockholders in the form of cash dividends, buying back their own stock, or submitting to takeovers. With a string of infamous bankruptcies still vivid in our minds, it’s understandable that companies are hanging onto their cash as a hedge. However, buy-out firms typically look for targets where they can use a company’s own cash to finance the acquisition. This puts executives under pressure to use that cash for investments, pay it out, or risk a hostile take-over. It’s happening already: In the first quarter of 2005, buybacks of stock jumped more than 90 percent, indicating that companies are responding to the cash glut.

Second, as U.S. investors get used to the new rules of this global economy, they’ll see the availability of cheap money as a way to fund the next wave of new technologies. When the cost of capital is low, research and development always get a boost. Consequently, everything from alternative energy sources and quantum computing to stem cell therapies and anti-terrorism security devices will see a great boost in the coming years. This will lay a more stable economic foundation on which the remaining global cash surplus can build, pushing capital to those places where it can do its most productive work.

Third, over the coming decade, as the developing nations, including China and India, begin to catch up, those same investments and technologies will begin to spread the glut of savings much more evenly around the globe. This will ease the U.S. current account deficit without triggering a steep decline in the dollar or a sharp rise in interest rates here. It will also help keep global inflation low, without the risk of it tipping over into a deflationary spiral.

Fourth, over the next decade, a huge group of consumers in those developing nations will experience a dramatic increase in their standard of living as a result of this global development; and they, in turn, will learn how to spend. In other words, consumption in those countries will rise ? and when it does, it will rise enormously, as people further down the global economic pyramid begin to demand cars, clothes, appliances, better homes, and even luxury items. This will ease the global savings glut and put the global economy on a more stable footing.

Fifth, one of the biggest areas of capital investment will involve building the next generation of energy production and processing capacity. For example, getting the Middle East oil fields up to full production capacity will require an investment of nearly $100 billion. The U.S., China, and Western Europe all desperately need to add refinery capacity. China, India and the U.S. are expected to build more than 100 nuclear power plants over the next two decades. As we move forward in the war on terrorism, tensions in the Middle East will ease, and quasi-democratic principles will spread. That will permit oil-rich countries to step up their investment in new resources, reducing their cash surpluses while enriching those nations and improving their standards of living. With an improved standard of living and a broad modernization of infrastructure in those nations, the incentives for radical activities will decrease as people begin to enjoy a new way of life.

Sixth, today’s “easy money” will lay the foundation for long-term investments in infrastructure, education, and research and development that will pay off in the coming generation. The long-term benefit of this cash surplus is that it coincides with an explosion in knowledge and opportunities. Today for the first time, companies are poised to offer breakthroughs like a car that sells for $2,500 in India; treatments that rejuvenate hearts, eyes, and spinal cords with stem cells; vaccines that prevent people from ever getting cancer or Alzheimer’s; genetically-engineered foods that end hunger; nano-tech factories that create new materials and devices with yet-to-be imagined benefits; and quantum computing technology millions of time more powerful than what we have today. The cash surplus means that entrepreneurs will have the cash necessary to realize these dreams and thousands of others as human knowledge continues to double every seven years or so.

References List :
1. The Wall Street Journal, July 11, 2005, “Cash-Rich Firms Feel Pressure to Spend,” by Gregory Zuckerman. ⓒ Copyright 2005 by Dow Jones & Company, Inc. All rights reserved.2. BusinessWeek, July 11, 2005 “Too Much Money,” by Rich Miller with Jack Ewing, Stanley Reed, Laura Cohn, Frederik Balfour, and David Henry. ⓒ Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.