An interesting article that might change your opinion on the markets: http://www.hussman.net/wmc/wmc100809.htm Hussman is arguing that the widely publicized notion that companies hold a lot of cash on their balance sheets, which can be used for capex / M&A is wrong. There is no such thing as cash on the sidelines because a lot of it is debt issued by other entities (corporates or governments), who have already used the cash. It definitely departs from how we have been looking at the world but I tend to agree with what Hussman is saying - securities issued must be held, savings equal investment, etc. Just wondering what everyone else thinks?
Dangit I thought this was Arial10…
I guess it would only be a problem ( as Hussman puts it ) if EVERYONE demanded their cash back at the same time for capex, buybacks, dividends, etc. i.e if you had all of that debt come on the market at the same time…which is unlikely to happen.
This article is pretty wrong in a number of ways. I’m disappointed as I had a positive impression of Hussman from previous research so had high expectations. “Now, yes, if the government runs a surplus and retires its debt, in aggregate, or the other companies that borrowed the money generate new earnings and then pay off their debt, in aggregate, then those new savings that retire the T-bills and commercial paper then make it possible for the recipients to finance new investment, in aggregate.” This is true about corporate debt, however it ignores the fact that the Fed stands ready to exchange Treasuries for cash on demand to meet their interest rate targets. The federal government running past deficits is the only way for cash to exist in the private sector, which can then circulate the economy and be used for economic activity. Here’s a thought experiment for you. The government runs a $1T budget deficit next year and the Fed buys all of those Treasuries up from the private sector. The Fed now has an accounting entry for a $1T liability that the government “owes itself”. The private sector now has $1T in cash that it did not have previously. There is no issue with someone having to buy anything from anyone else, it’s just cash. If “animal spirits” are in decent shape these new reserves can circulate through the economy perpetually until taxed to prevent inflation. If you take Hussman’s argument to its logical conclusion there would never be any investment anywhere ever because all cash will eventually be owed back to the government in the form of taxes. As this is clearly not the case I think Hussman would be wise to reconsider his argument. Companies have plenty of cash and borrowing ability to invest if and when there is demand for the things they would invest in. It’s as simple as that.
I’ve been uncomfortable with Hussman’s argument for some time, and I think Dwight has managed to find the “leak” that I sensed was there. In addition, there may be an issue if the term structure of US debt gets changed, and also a question of how the quantity of cash changes when interest on debt is actually paid to bondholders. But in the very short term (say weeks or months), it is reasonable to say that the quantity of “cash” and “cash instruments” does not change substantially (barring major Fed actions), and so Hussman is correct that the phrase “there is lots of cash on the sidelines” doesn’t really make much sense when taken literally. SOMEONE is always holding currency and Treasurys, and the fact that it was used to buy a stock or real estate or something doesn’t make it wink into and out of existence. It is fairly constant over time. So then the question in my mind has been how to understand the relationship between cash and asset prices. Even if “having lots of cash on the sidelines” isn’t a perfectly accurate description, it does describe a kind of condition that is different than the norm. It seems to be more about the “price of risk” and the relative value between risk-less (at least traditionally riskless) assets and something risky like a stock, bond, or real estate. If you figure that economic actors’ ability to take risk is roughly constant over time, then holding a higher percentage of cash to risky assets means that the price of risk is not high enough to induce them to put stuff in risky assets, whether or not the total quality of cash in society is constant.
correct me if I am wrong here. But isn’t the fact that interest rates are at rock bottom indicate cash is in fact sitting on the sidelines? I mean, Tbills are essentially cash no? ppl don’t want to invest in things aside from tbills, hence, ppl are just holding cash.
Good points. Another interesting thing to note is that there have been equity outflows for a few years now and the stock market has gone up regardless. The “cash on the sidelines” argument has some holes in it certainly, but one of them is definitely not “the government needs to run surpluses before businesses can invest”. “If you figure that economic actors’ ability to take risk is roughly constant over time, then holding a higher percentage of cash to risky assets means that the price of risk is not high enough to induce them to put stuff in risky assets, whether or not the total quality of cash in society is constant.” I think this is right - but you mean the price of risk is not LOW enough right?
Dwight I tend to understand “the price” of risk as “the expected return for that risk”. It is a little confusing, because when the expected return is not high enough, that means that the present value of an asset discounted at that expected return is not low enough. So when the “price of risk” is high, the “price of a risky asset” is low. On the same topic, one can model that people’s ability to take risk is related to their total wealth, too, so that as asset prices decline, the willingness and ability to take risk both decline. That factor then moderates the multiple that one should put between cash and an appropriately priced risky asset. The interesting interpretation here is that that the quantity of cash can be thought of as roughly constant a la Hussman, but the multiple reflects changing risk appetites. When I teach this stuff, I do like to try to link multiples to sentiment. Students often want to mechanically derive justified PE multiples and things, or just slap a historical multiple onto an earnings projection to get a fair value, but a more nuanced view is to try to look at how risk premiums change based on psychological factors. We never have time to get into the behavioral finance approaches to this, but it’s important to make sure that people understand where the math ends and the interpretation begins.