The changing mix of Corporate Liquidity.

• Author: Avers, Jeffrey P.
• Position: Treasury

Standing at $5.4 trillion as of mid-2006, U.S. corporate cash is at an historic level. With year-over-year growth of $400 billion, or roughly 7.5 percent, it's continued on this same upward trajectory since the century began.

What has been driving this growth in cash? Unlike the cash build-up in the mid- and late 1990s, whose roots were seeded in the initial public offering (IPO) market, participants in Treasury Strategies' 2006 Corporate Liquidity Survey cited internally generated cash (cash flow from operations) as the number one driver of this unprecedented build-up. Indeed, as of mid-2006, the S & P 500 had seen a record 17 consecutive quarters of profit growth--and higher profits usually translate into more cash in corporate coffers.

Another driver in the cash build-up is the way corporate America has been hoarding cash rather than reinvesting in its core business, as it had done previously. Those that have increased their capital investments in recent years were more likely to have taken advantage of the historically low borrowing rates over the last few years.

From the perspective of the traditional statement of cash flows, the combination of an increase in cash flow from operations with flat or declining capital expenditures will likely increase year-over-year cash. While U.S. corporates are using some of this cash to pay down debt and effectively recapitalize the balance sheet, they are not using it to fund capital expenditures for financing internally generated growth at a rate that one might consider consistent with an economy that has produced 17 consecutive quarters of corporate profit growth.

Is this a precursor of an economic slowdown? Maybe, but we can't jump to this conclusion solely based on the build-up of balance sheet cash. It's logical that a period of unprecedented earnings growth would generate an unprecedented amount of cash, but if corporations are not aggressively reinvesting, that is of concern to economists and Wall Street analysts.

Other factors causing corporates to put expansion plans on hold might include concerns over the Iraq war, fear of terrorist attacks, increased scrutiny from shareholders, regulators and Wall Street, as well as concerns about the implications of a Democrat-controlled Congress.

Also, this economy seems more interested in growth through acquisition than in internally-generated growth, as evidenced by the fact that $2.3 trillion in M & A deals were announced in 2006. With reports that...