Kevin Drum asks why non-financial firms have been holding a growing amount of cash and muses as to whether this lends credit to the great stagnation thesis. He is referring to a graph published on The Washington Post,
While I can’t discount it for sure, I don’t think this is evidence in favor of the theory that we’re suffering from lessening opportunity for net investment. In fact, rising cash balances amongst firms isn’t necessarily a sign of falling investment. In fact, much of that rise in liquid assets is likely to represent alternative investments.1 Specifically, with the development of new financial instruments — securitization, namely — new opportunities for firms to invest along less traditional lines, if you will, opened up. Wholesale credit markets became popular attractions for banks looking for short-term liquidity to fund long-term lending. So non-financial firms lend large amounts of cash to financial firms. Typically, banks post their assets as collateral. Wholesale credit channels, such as repo and commercial paper markets, became especially vibrant during the past two decades.
Now, I admit I don’t know how much my theory explains, but I’m convinced it has much to do with it. On the other hand, there are other things to consider. Idle capacity has also been growing at a considerable rate, and I don’t know if there’s any relationship between that and this (or between idle capacity and growing opportunities for alternative investments). But, I’m sure there are many forces at play.
1. The sentence originally made more sense: “alternative investments” read “malinvestment.” But, I realized that this may be misleading, since alternative investments aren’t necessarily malinvestment. It’s just that historically that rise in liquid assets reflects a lot of wholesale lending that ultimately saw its way to homeowners. In other words, non-financial firms became increasingly involved, even if indirectly, in fueling the housing bubble.