"Transitions are dangerous," said the late Charles Kindleberger, an economic historian with a vast knowledge of financial manias, panics and crashes, in 1983. That was No. 9 of 10 lessons he summarized from the early years of the Great Depression.
Kindleberger noted that pursuit of smart public policy in that tumultuous time was handicapped by three transitions: The 1928 death of Benjamin Strong, the forceful head of the Federal Reserve Bank of New York, which caused power to pass to the Federal Reserve in Washington, a more timid group of central bankers; the victory in the 1932 Presidential election of Franklin D. Roosevelt over the incumbent Herbert Hoover; and the difficult transition of international economic hegemony from the world of Pax Britannica to Pax Americana.
Since economist James Tobin got the Nobel prize in 1981 for stating "don't put all your eggs in one basket," Kindleberger said he planned on submitting to the awards committee his one-sentence insight: "Be very careful if you have to change horses."
Kindleberger never got the nod from Oslo, but his admonition rings true a quarter-century later. The midterm election is over, and the results have changed the balance of power in Washington, with the Republican Party picking up at least 60 seats in the House—the biggest sweep since 1948. Democrats held on to the Senate, but with a slimmer majority after Republicans picked up at least six seats.
Voters are understandably angry over the lack of jobs and economic growth. And the news remains grim on the employment front. While the U.S. economy added 151,000 jobs in October, the unemployment rate held at 9.6 percent, the Bureau of Labor Statistics reported on Nov. 5. That's the 15th month the jobless rate has remained at 9.5 percent or above, the longest such period since government statisticians started collecting the numbers in 1948.
Indeed, the major force behind the slow recovery isn't going away soon: America is turning away from debt and embracing thrift, and the epicenter of change is the household. History suggests that the transition toward a high-saving, less-debt balance sheet will be long and painful before vibrant growth resumes.
The Federal Reserve is smartly trying to bolster the economy during the transition from profligacy to thrift with its latest round of quantitative easing, QE2 (a fancy term for printing money). The Fed announced Nov. 3 that on top of its existing program of reinvesting the proceeds of its portfolio, it will buy $600 billion of long-term government bonds by the middle of 2011. In the meantime, the message for Capitol Hill and the White House is, at minimum, "do no harm" while the Great Deleveraging runs its course.
Considering the well-publicized extravagance of many chief executives, it's underappreciated just how much money Corporate America has been hoarding cash during the downturn. Corporations have accumulated nearly $1 trillion in cash and equivalents, up 22 percent since 2008, according to an Oct. 27 report by Moody's Investors Service. Apple Computer (AAPL) alone has $51 billion on its balance sheet. "The investment opportunities are more limited, and most can wait until management is more confident about demand," says Charles Roxburgh, the London-based director of the McKinsey Global Institute.
The recent corporate embrace of cash is really part of a longer-term trend. It started after the economic trauma of the 1970s, when companies were battered by one shattering experience after another, from double-digit inflation and interest rates to the U.S. government abandoning the gold standard, to the two OPEC oil embargoes. Despite all the headlines devoted to LBO buccaneers in the 1980s and private equity financiers in the 2000s, the average cash-to-asset ratio for U.S. industrial companies increased 129 percent from 1980 to 2004, according to scholars Thomas Bates and Kathleen Kahle of the University of Arizona, Tucson, and Rene M. Stulz of Ohio State University. In "Why Do U.S. Firms Hold So Much More Cash Than They Used To?" the researchers note that the creation of the cash hoard has been so dramatic that "on average, American firms could have paid off their debt with their cash holdings."
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