Why Aren't Companies Spending?

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Includes: DIA, QQQ, SPY
by: FinancePM10b

On my RSS reader yesterday, I came across two interesting articles on spending. The first one by Paul Krugman, “Why Isn’t Investment Higher?” in which he provides an interesting take as to what companies are doing with record levels of cash. The second article is by an economic columnist of the Washington Post presenting an argument in-line with Krugman’s analysis, while also presenting a counter theory.

Krugman states that the perception companies are not spending because of speculation on anti-corporate government policies is a myth. Rather, he hypothesizes that businesses are experiencing excess capacity. It’s a short and simple read as the Nobel Laureate displays the relationship between output gap and investment. The graph () demonstrates that economic output is decreasing faster than the decrease in business investment, suggesting the opposite. This may be a signal that companies may in fact be bullish, suggesting a sense of confidence, maybe even extreme optimism.

(Source: Krugman blog)

One of my favorite columnists, Ezra Klein, of the Washington Post, wrote an interesting piece entitled “The Confidence Game” presenting an argument on why business spending is low. Along with supporting Krugman’s thoughts, he also adds that there is a low demand for goods, largely attributed to high unemployment levels. I found this interesting, and even contradictory, as his theory is that the lack of spending is attributed to fears of another recession, thus businesses are saving capital to persevere through the expected tough times.

In theory, cash hoarding is generally an indication of fear and uncertainty. However, Krugman may have found an exception to this concept by demonstrating an output gap decrease larger than the decrease in net business spending. Karl Denninger, a Seeking Alpha contributor, wrote a post entitled “The Fallacy of ‘Record Corporate Cash’” in which he argues that today’s record levels of cash are a red flag that growth prospects are declining, not improving. Thus there is no clear incentive to increase capital expenditures, engage in M&A activity, and hire more workers.

Ezra Klein and Karl Denninger may be right that record amounts of cash positions and lack of spending are a forward looking indicator that businesses are taking into account an expectation of slow down. But I believe Krugman takes it a step further with a simple macroeconomic analysis demonstrating that businesses aren’t fearful, rather at over capacity.

The lesson here is that economic trends cannot be supported by theory alone, but rather by analyzing key data points. In today’s economic climate, very little makes sense, thus incorporating a textbook definition alone does not explain true economic activity.

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