2000s >> 2006 >> no-1227-november-2006

Cooking the Books 1: Abnormal behaviour

The Bank of France is worried. Capitalist enterprises, it seems, are not behaving normally

In an article entitled Is the investment behaviour of enterprises normal’” in the August issue of its Bulletin (www.banque-france.fr/fr/publications/telechar/bulletin/152focus.pdf), the Bank notes that enterprises in the G7 countries (US, Japan, Germany, Britain, France, Italy and Canada) are registering very strong profitability and that as a percentage of GDP enterprise profits are at their highest level for decades, but that an unusually high proportion of these profits are not being reinvested in production. Some (most in fact) are of course but what is not normal, according to the Bank, is that in 2005 the enterprise sector of the economy was a net lender to other sectors, which is disconcerting as one would normally expect enterprises to be in general net borrowers (i.e., to be borrowing money to invest in production), adding in fact this has always been the case up till now and that it is particularly surprising to note that investment is not more dynamic when long-term real rates of interest are at their historical lowest level.

Two questions arise. If they are not investing enough, what are enterprises doing with the extra profits? And, more fundamentally, why are they not investing them?

The Bank identifies a number of ways in which enterprises are using the profits that they are not investing. First, holding them as liquid assets (placed on financial markets in forms that can be readily be converted into cash): liquid assets represent 9 percent of their total assets, a level that is difficult to explain by any historical precedent or traditional economic approach. Second, distributing them to shareholders. Third, spending them on taking over other enterprises.

As to why, the Bank offers two scenarios. In the optimistic one, the current underaccumulation of physical assets is seen as the other side of the coin to the overaccumulation that took place in the 1990s; in other words, as one phase of the capitalist business cycle; sooner or later the profit hoards will disappear as they are absorbed by rising wages and interest rates when the cycle moves on to its next phase.

In the less optimistic scenario, the unusually high level of uninvested profits is seen as the result of investment in physical assets being more risky than placing the money on financial markets. The Bank lists three reasons as to why investment is currently regarded as being too risky: geopolitical uncertainties, anticipated inevitable exchange rate adjustments, and the threat of protectionism.

At the moment, the Bank says, this can only be conjecture, but:

A situation where the risk premiums of physical assets are very different from those of financial assets cannot go on for ever. In the long term financial assets only reflect an underlying real economic reality. These two categories of risk premium can in time only converge”.

The Bank says that it is of the greatest importance for the world economy that this process [of convergence] should take place in an orderly manner
(ie., without a financial crash and its consequences), but doesnt seem too optimistic that it will. It might of course. We shall see. In any event, what sort of economic system is it in which it is normal to have to rely on whether or not a big enough profit can be made to get things produced?

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