The Economy In 2014: How Is All The Cash Being Used?

The United States economy is in its fifth year of recovery from the Great Recession, although the pace of the recovery remains modest.

I expect that in 2014 we will enter the sixth year of this economic recovery, but the pace of economic growth will remain tepid. I just don't see the economy growing outside the 2.0 percent to 2.5 percent range.

There are two primary reasons I continue to opt for such a picture of slow economic growth.

The first is that there are many structural problems that exist within the economy that are not being addressed as people in government fight the old battles while letting the future fritter away.

The second is that the money that the Federal Reserve has pumped into the economy is not going to be used by banks and other businesses in productive ways.

I have written many posts over the past few years concerning the first of these issues. The problem here is that the human and physical capital of the economy are being wasted and are not being used as well as they might be used.

In the aggregate sense, the human and physical resources of the United States are being under-utilized and nothing is being done about it. For example, the under-employment of labor in the United States is still running close to one-in-five of the labor force. The labor participation rate in the United States is now around 63 percent, a figure one has to go back more than thirty years to find such a low number.

Furthermore, capacity utilization in the United States is below 80 percent and I believe that this figure understates somewhat the "real" shortfall in capital utilization.

Governments, federal, as well as state and local governments, are doing little or nothing to address these issues. They just keep their focus on short-run efforts to pump up the economy through more and more injections of credit inflation.

And, this gets me into the second problem which is connected to all the cash that has been pumped into the economy over the past fifty years and the expectations that such credit inflation has on how the private sector allocates resources.

The United States economy is awash with cash. Providing such liquidity to the economy has been the primary objective of the Federal Reserve System over the past six years or so. But, the question is, how is this cash being used in the economy?

The first response to this is that commercial banks are sitting on a large portion of the cash. In November 2012 the commercial banking system of the United States recorded a total of cash assets on its aggregate balance sheet of around $1.7 trillion! This was an unheard of amount of excess cash being held in the banks.

But, now we get to December 2013 and this total has gone up by another trillion dollars! That is, the commercial banking system is averaging around $2.7 trillion in cash assets on its balance sheet in December of 2013!

Two possible conclusions for this behavior: first, loan demand is very weak; second, many commercial banks are not in very good condition and can't expand their loan portfolios. Of course, it could be a combination of the two. Either way, it is hard to believe that the banking system, as a whole, is in very good shape.

Furthermore, over the past five years, large corporations have piled up billions of dollars in cash reserves. Businesses that came through the Great Recession is good shape found themselves with a lot of cash on hand. And, with the interest rates so low, many corporations even added more cash balances to their accounts by issuing bonds. Some of these companies, like Microsoft, had never ever issued debt before.

Some analysts, myself included, believed that the corporations were building up these cash reserves to go on an acquisition binge as the economy recovered. But, the acquisition binge did not take place…either because of the weakness of the economy or the uncertainty connected with the economic policy of the federal government…or both!

So what happened? Corporations used a lot of these monies to buy back stock. The bottom line…the companies did not have any better use for the money so they bought back their own stock. This does not say much about the confidence these corporations have in the future.

The other major use of the cash being injected into the economy has been for "speculative" purposes. Over the past fifty years, wealthy investors have discovered that they can make lots and lots of money by taking advantage of the credit inflation created by the federal government. The result of this discovery has been the growing income/wealth inequality that has taken place in the United States since the early 1960s.

The "expectations" created by government policy can lead to wealth allocations that do not do much to contribute to productive output but can produce substantial amounts of financial return. I have noted in several recent posts about the activity of the Blackstone Group (BX) and their acquisition of homes that will be put up for rent. And, there is the move by Berkshire/Hathaway into real estate brokerage among other things. And, this is just the tip of the iceberg by some relatively prominent sources.

As everyone can see by looking at the statistics, there is a lot of cash around. The source of these funds has been Mr. Bernanke and the Federal Reserve and their fear that the Great Recession would turn into a second Great Depression.

Right now, that cash is keeping the commercial banking system afloat, helping to inflate stock prices, and contributing to a greater inequality of income/wealth distribution. In other words, the cash is allowing the economy to grow but, at present, it is not producing the kind of economic growth most of us would like to see.

This is why I believe that it is very important to keep an eye on how this cash is being used, or…in some cases…not used. If commercial banks feel healthy enough to begin lending again; if corporations begin using their cash balances to invest in capital goods; and if hedge funds, private equity funds, and other alternative financial sources, cease to "speculate" on government economic initiatives and begin to invest, once again, in productive ways…then we might expect greater economic growth and a better use of our resources.

We still will require that attention be given to the longer-term structural issues of the economy.

For the next year, however, let's see what people do with all the cash that is floating around in the system. How these people use the cash they have will define, I believe, how investors should pursue their investments.

Source: The Economy In 2014: How Is All The Cash Being Used?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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