With interest rates still at record lows, you’d be forgiven for thinking corporates would be falling over themselves to borrow and invest. However, according to Capita Asset Services, total net cash held by FTSE 100 corporates, excluding financial companies, has surged 41% to £53.5 billion over the past 12 months.
The reason behind such caution can only be a poor outlook for future demand. In order to unpick this conundrum, we must delve into the realms of economic theory…
From Marx to Keynes…
Contrary to the popular misconceptions among many a lefty, Marx only set out what he thought were the inherent contradictions and tensions within the capitalist system which he believed would ultimately tear it apart; he did not provide a ‘blueprint’, as it were, for how Communism should take shape – that was left to those revolutionary (and invariably murderous) leaders whom he inspired.
Ultimately however, the central tenet of his worker-capitalist relationship theory which stipulated that the capitalists’ constant drive to lower costs would take an ever greater toll on workers’ living standards was simply shown to be incorrect; in fact, workers’ living standards have risen steadily and consistently over the long term, and the distinction between the ‘worker’ and the ‘capitalist’ has become blurred.
Marx
As for Keynes – the Great Man whose ideas Labour constantly fumble towards in their fight against so-called ‘austerity’ – well, his solution would probably be to spend our way out of our current ills (although he would certainly have balked at the level of budget deficits in the good years). Of course, when Keynes was writing in the 1930s, this solution was positively revolutionary; nowadays, it is positively reactionary.
Those who advocate increases in spending in the current fiscal environment are playing a very dangerous game of ‘chicken’ with the bond market. But perhaps more importantly there is now myriad evidence that the fiscal multiplier – Keynes’s ‘lever’ on the economy – simply doesn’t work. In fact, the fiscal multiplier is now believed by some economists to be relatively insignificant or even non-existent, particularly in open economies with flexible exchange rates and high debt (like the UK & US).
This could help explain why growth in the UK has been stagnant despite increases in government spending in recent years. Furthermore, all the empirical evidence suggests that economic performance after an expenditure-based fiscal retrenchment (i.e. spending cuts) is better than after a tax-based fiscal retrenchment (tax rises).
Keynes
Why Hayek is being proved right…
Hayek made his name studying the business cycle. He believed that any attempt by the state to intervene in the economy for political ends would lead to unintended – and often pernicious – consequences. To illustrate this, let us consider the financial crisis of 2007-09 and its aftermath.
At the root of this crisis lay the excessive lending practices of banks, spurred on by the laudable but misguided political aim of widening the scope of home ownership across the social spectrum. Central banks are, by their very nature, price fixers in that they set an interest rate level that would not naturally occur under free market conditions where the demand for credit and the supply of savings were allowed to find equilibrium.
The interplay between savings and investment is one of Hayek’s most important contributions to economics, but is often overlooked these days. This distortion of the price level sends out the wrong signals to businesses and consumers who then undertake investment and consumption activities at the marginal level (i.e. that have only been made possible through artificially cheap credit). A bubble ensues – in this case, in the housing market – followed by a collapse, as it becomes clear that the current level of activity is not supported by real savings.
To counter the fallout, the authorities have resorted to the very same tool that got us into this mess in the first place – cheap credit. But they haven’t stopped there.
Quantitative easing has distorted the market even further and has stoked a huge bubble in the bond market. By ensuring that interest rates remain lower than they would otherwise be, the authorities are preventing the market from doing its job of liquidating unproductive investments and reallocating labour and capital. The result: economic stagnation.
Recessions are clearly not very palatable events (especially for politicians!), but they are necessary events nevertheless. As Hayek demonstrates, the state’s constant intervention in the business cycle ensures that recessions become increasingly severe and long-lasting, as imbalances within the economy are allowed to fester under a protective umbrella of cheap credit.
The problems this presents for investors…
These imbalances weave their way into the financial markets and can leave investors significantly out of pocket – just look at what happened to the share prices of many a housebuilder and retailer during the financial crisis. However, it has become clear that the liquidation process has further to go as the high profile corporate failures continue in spite of the economic recovery.
Although inflation seems to be weak at present, we don’t believe we’ve seen the last of that notorious destroyer of wealth just yet, as ballooning debt levels will no doubt continue to be monetised by the Old Lady et al when necessary. Accordingly, we remain positive on gold and favour exposure through gold mining shares given their huge divergence from the gold price of late.
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