Wednesday, December 22, 2004

In today's Washington Post, Robert Samuelson sees an important disconnect in the popular common sense story of capitalism.
Since their recent low in late 2001, after-tax corporate profits have surged by more than 70 percent; but business investment -- in new computers, software, machinery and buildings -- has revived only modestly, increasing about 18 percent.

Capitalism isn't supposed to work this way. Soaring profits usually signal new investment opportunities and provide the cash to exploit them. Indisputably, cash is plentiful. Since 2001 corporate cash flow is up 42 percent and is now running at a record rate of $1.3 trillion annually (cash flow is essentially the sum of undistributed profits and depreciation -- depreciation being a non-cash expense to reflect the obsolescence of existing plants and equipment). But companies aren't aggressively deploying all that money in new products, factories or markets.
Unfortunately, Samuelson tries to put capital on the couch to figure out why this might be the case. Since he can't see any politics in the economy, it must be psychology.
The disconnect reflects a sea change in corporate psychology. Call it the return of "risk aversion" -- a fancy phrase for caution. In the late 1990s, the idea of risk virtually vanished. The business cycle was dead; stocks would always rise; globalization was good; the Internet was empowering; CEOs were heroes. Anybody could do anything. Not to worry. Now risk has revived with a vengeance.
Calling this "risk aversion" is a cute slight of hand. I'd call it "profit maintenance". This is the Age of Overproduction. Capital knows that big new greenfield investments in such an environment will simply boost production, lower prices, and undermine their profit margins. Does anyone really believe there are great untapped sources of demand (economic demand backed up by income/assets, not biological or moral demands) in the United States just waiting to be discovered? Of course not.

According to Federal Reserve data, production capacity in manufacturing excepting computers, communications equipment and semiconductors has been stagnant for four years. The same is true if you want to measure it as manufacturing excepting hi-tech and motor vehicles & parts. And we all know that private sector employment is still down 1.2 million jobs, 45 long months after the jobs peak.

Thus with few prospects for profitable new investment, hording cash, reducing overhead costs and even eliminating production capacity via M&A activity makes perfect sense, regardless of Samuelson whining that capitalism "isn't supposed to work this way".

And we need psychology to explain this to us?


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