So just why are companies sitting on vast lakes of cash?

It's not an unusual complaint these days, companies sit on vast lakes, reservoirs' worth, of cash and don't seem to do much with it. Something must have changed so what is it? At least part of the answer, accounting for just under a third of it, is that the world of business has changed. Well, obviously, but we've identified one of the ways that it has

I explore the role of the just-in-time (JIT) inventory system in the increase in cash holdings by U.S. manufacturing firms. I develop a model to illustrate the mechanism through which JIT affects cash and quantify its impact. In the model, both cash and inventory can serve as working capital. As firms switch from the traditional system to JIT, they shift resources from inventory to cash to facilitate transactions with suppliers. On average, this switchover accounts for a 4.1-percentage-point increase in the cash-to-assets ratio, which is approximately 28% of the change observed in the data.

Back decades a company might sit on months of inventory, today perhaps hours. That needs less working capital to finance the inventory of course, but also more ready cash to pay suppliers. What happens to the net investment position depends upon the balance of those two effects.

Our own guess at it, and it is a guess, would be that the reduced working capital demands outweigh the greater liquidity demands. Thus rather neatly explaining something else people seem to worry about, the decline in corporate use of capital itself.

There is also a larger point to make here, we must always be very sure that we are distinguishing cyclical changes from structural. It is possible, for example, that people might use corporate demands for cash or working capital as a measure of the state of the economy. OK, fine, why not do so? But when we do so we've got to make sure that as the underlying technology, and thus the structural demands, change we do not confuse the two, the structural and the cyclical.

Our favourite example of this error was a measure of business software investment. That this is static was used to argue that there was no great technological revolution going on and therefore we faced secular stagnation. The problem being that business increasingly rents its software, not buys it. Office and Office 365 both do the same thing, but Office is an investment, 365 a current expense. Business was indeed therefore "investing" more in software, by the amount of the size of the software as a service market, but this was completely missed by the use of the investment statistic.

Or, as we like to say, it's no use looking at an economic statistic unless you understand, in detail, what it is actually measuring and why