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Time Preferences


Today's durable goods report, and the details beneath the headline number, are suggestive of a larger question we debated on the Buzz a few weeks ago. Specifically, it now appears that capex economy-wide is looking like it will only be up 1% Q/Q in Q2:05 versus the 7%+ estimates that economists had as recently as several weeks ago.

But this doesn't make 'sense' given what we know about corporate balance sheets: they are flush with cash. In fact, the fact they started off the year with such a healthy balance sheet is what made strategists so bullish on capex-related industries. All that money just sitting there, waiting to be spent.

But alas it does not appear that it is being spent. Some economists are suggesting that the accelerated tax benefits in 2004 that were sunset for 2005 are the cause of this capex cut. But a look at the smoothed moving average of the last several months shows this to be a developing trend, not a one month fluke.

Whatever the debate about the underlying figures and what they really mean, the important point is this: there is a near record amount of cash on corporate balance sheets that is decidedly not making its way into the economy in capital expenditures. Why is that?

We think the answer lies within a debate we had a few weeks back on the Buzz with Jason G regarding the presence of substantial cash and available margin at retail brokerage accounts. We said at the time that it's important to understand that the cash is there but perhaps more important to understand why the cash is there. Are investors increasing their time preferences (reducing their desire to take on risk) or is some other process at work?

The same question should be asked of CFOs and CEOs: they have a record amount of cash to spend, but for some reason they are choosing not to spend it (on capex anyway, stock buybacks and mergers are seemingly more attractive uses to these folks). Why?

It will probably not surprise you to hear us say that the same type of increase in time preferences that we see at work on the retail investor side is a probable cause for the spending reticence we may be seeing on the commercial side. An increase in time preferences results in a desire to take less risk. It results in deflation.

That's what we think lies behind the curious situation the economy finds itself in. And for an economy as heavily levered as this one is, such a shift in time preferences could have disastrous consequences.
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