El-Erian: 6 Reasons Why Capex Is Constrained

Tyler Durden's picture

Following last week's confirmation that capital expenditure in the land of the Free runs a very poor third to buybacks and dividends (and well anything that props up the over-inflated share prices of US corporates), and merely confirming what we have been discussing for the last few years (that Fed policy has focused management on short-term gratification and not long-term growth and stability), ex-PIMCO shit-cleaner-upper Mohamed El-Erian notes six reasons why the collapse in capex spend will continue and how central banks have failed to prime the pump of the real economy.


As a reminder, capex is printing "recessionary" levels...

For now the only number that matters is the capital goods orders nondefense aircraft, aka core capex. It is here that while the sequential print was a modest increase of of 1.7%, compared to expectations of a -0.2% decline, it is the annual number that is of interest. We focus on this, because as can be seen on the chart, the annual change just posted its first annual decline in a year: in the past any such decline would mark the start of a recession, except of course for in 2012 when the New Normal central planning, and the trillions in Fed liquidity injections, made the business cycle as we know it meaningless.


So much for that $1+ trillion in QE: it is good to know that it went to stock buybacks and dividends... if not so much to actually investing in future growth.



Authored by Mohamed El-Erian, originally posted at Project Syndicate,

Some economists, like Larry Summers, call it “secular stagnation.” Others refer to it as “Japanization.” But all agree that after too many years of inadequate growth in advanced economies, substantial longer-term risks have emerged, not only for the wellbeing of these countries’ citizens but also for the health and stability of the global economy.

Those looking for ways to reduce the risks of inadequate growth agree that, of all possible solutions, increased business investment can make the biggest difference. And many medium-size and large companies, having recovered impressively from the huge shock of the 2008 global financial crisis and subsequent recession, now have the wherewithal to invest in new plants, equipment, and hiring.

Indeed, with profitability at or near record levels, cash holdings by the corporate sector in the United States have piled up quarter after quarter, reaching all-time highs – and earning very little at today’s near-zero interest rates. Moreover, because companies have significantly improved their operating efficiency and lengthened the maturities on their debt, they need a lot less precautionary savings than they did in the past.

However one looks at it, the corporate sector in advanced economies in general, and in the US in particular, is as strong as it has been in many years. Non-financial firms have achieved a mix of resilience and agility that contrasts sharply with prevailing conditions for some households and governments around the world that have yet to confront adequately a legacy of over-leverage.

But, rather than deploy their abundant cash in new investments to expand capacity and tap new markets – which they have been very hesitant to do since the global financial crisis erupted – many companies have so far preferred (or have been pressured by activist investors) to give it back to shareholders.

Last year alone, US companies authorized more than $600 billion of share buybacks – an impressive amount by any measure, and a record high. Moreover, many companies boosted their quarterly dividend payouts to shareholders. Such activity continued in the first two months of 2014.

But, while shareholders have clearly benefited from companies’ unwillingness to invest their ample cash, the bulk of the injected money has been circulating only in the financial sector. Little of it has directly benefited economies that are struggling to boost their growth rates, expand employment, avoid creating a lost generation of workers, and address excessive income inequality.

If advanced economies are to prosper, it is necessary (though not sufficient) that the corporate sector’s willingness to invest match its considerable wallet. Six factors appear to pose particularly important constraints.

First, companies are concerned about future demand for their products. The recent economic recovery, as muted as it has been (both in absolute terms and relative to most expectations), has been driven by the experimental policies that central banks have pursued to sustain consumption. Now, with the US Federal Reserve beginning to withdraw monetary stimulus, and with growth in emerging countries slowing, most companies are simply unable to point to massive expansion opportunities.


Second, with China such an influential driver of global demand (both directly and indirectly through important network effects), the outlook for the world’s second-largest economy has a disproportionate impact on projections of global corporate revenues. And, as China’s excessive domestic credit growth and shadow-banking system attract increased attention, many companies are becoming anxious.


Third, while companies recognize that innovation is a key comparative advantage in today’s global economy, they are also humbled by its increasingly winner-take-all nature. Successful innovation today is a lot less about financing and much more about finding the “killer app.” As a result, many companies, less convinced that “normal” innovation yields big payoffs, end up investing less overall than they did before.


Fourth, the longer-term cost-benefit analysis for would-be investors is clouded by legitimate questions about certain operating environments. In the US, many companies expect major budgetary reform; but they are not yet able to assess the impact on their future operating profits. In Europe, politicians are aware of the need for major structural reforms, including those required to solidify regional integration; but companies lack adequate clarity about the components of such reforms.


Fifth, the scope for risk mitigation is not as large as financial advances would initially suggest. Yes, companies have more hedging tools at their disposal. But the ability to manage downside risk comprehensively is still limited by incomplete longer-term markets and public-private partnerships that cannot be sufficiently leveraged.


Finally, most corporate leaders recognize that they owe a large debt of gratitude to central bankers for the relative tranquility of recent years. Through bold policy experiments, central bankers succeeded in avoiding a global multi-year depression and buying time for companies to heal.

But, working essentially alone, central banks have not been able to revamp properly the advanced economies’ growth engines; nor do they have the tools to do so. Though many corporate leaders may still be unable to grasp the precise threats, they seem uneasy about the longer-term collateral damage implied by running modern market economies at artificially repressed interest rates and with bloated central-bank balance sheets.

The good news is that each of these constraints on investment can – and should – be addressed; and recent US business investment data suggest some progress. The bad news is that it will take a lot more time, effort, and global coordination. In the meantime, the corporate sector will only gradually take on more of the heavy lifting. That will be enough to keep the advanced economies growing this year; unfortunately, it will not be enough to attain the faster growth that their citizens’ wellbeing – and that of the global economy – urgently requires.

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knukles's picture

Same 6 reasons that my future at PIMPCO was restrained.

Clayton Bigsby's picture

"Ex PIMCO shit-cleaner-upper" - LOL'ed on this one - well played, sirs...

0b1knob's picture

1.) Overcapacity.

2.) Overcapacity.

3.) Overcapacity.

4.) Overcapacity.

5.) Overcapacity.

6.) Overcapacity.


Leveraged Algorithm's picture

Your forgot...
7. Massive Debt....

Grande Tetons's picture

El Erian seems like the real deal.  I have not heard much dirt about him. He must be a closet kitten juggler or something. Sometimes, it seems honesty accidentally slips out.


On the Wednesday and Thursday after Lehman filed for Chapter 11, I asked my wife to please go to the ATM and take as much cash as she could. When she asked why, I said it was because I didn't know whether there was a chance that banks might not open. I remember my wife sort of pausing and saying, "Are you serious?" And I said, "Yes, I am." We had long felt that the world was increasingly in disequilibrium, and by March of 2008 we decided that things were critical and that the unthinkable was thinkable. 

El Erian. 

IridiumRebel's picture

Yes, but what about Ukraine?

RaceToTheBottom's picture

"central banks have not been able to revamp properly the advanced economies’ growth engines; nor do they have the tools to do so."


Still looking for one fox to control the actions of the other foxes attacking the henhouse.

They should start looking at the real picture and asking the real questions:

Does it make sense to have the fox guard the henhouse?

Blammo's picture

I have Colonel Sanders guarding my henhouse...He eats fox's for lunch!

Danno Anderson's picture

The money is supposed to stay at the top where the NYC Banksters have full control of it, borrowing at 1/4% from the US Federal Reserve and loaning it back to the US Treasury for 3 1/4%, all risk free of course.

Implying that QE's one Trillion dollars should or could have circulated in the general US economy is just too quaint.  It was always designed to stay at the top from the beginning. 


disabledvet's picture

this is a great comment...and you should read the article "why reverse repo's are the same as QE."

This is like Worldcom...where "well, i'll just call the liability an asset now" only in this case "it's reversed."
It's still just "nomenclature"...a "naming device."
The debt is still being "monetized" in the sense that M2 will remain "at or near zero." El Arian just doesn't get it.

"Welcome to Tartarstan."

nightshiftsucks's picture

El-Erian is so smart he's fucking stupid.Who's going to buy all the shit to keep the economy going ?

Grande Tetons's picture

He is being diplomatic in the open sense. The test between his lines is easy to read..bla bla bla..THE ECONOMY IS FUCKED....bla bla bla...THE ECONOMY IS BEYOND FIXING...bla bla bla.

Midnight Rider's picture

You are right and he stated it in his summary. A very diplomatic way of saying even if they do everything on my list, we are still screwed. Knowing this, companies are going to continue to save themselves until either some kind of force intervention along the lines of what should have been done in the first place rather than bailing out the crisis creators, or we implode first and then there may be no choice but to do such an intervention on the real economy. Or face a few lost decades or more from that point. At least for the 99%.

"If advanced economies are to prosper, it is necessary (though not sufficient) that the corporate sector’s willingness to invest match its considerable wallet."

disabledvet's picture

the Fed will.
since they have no gold (backed money) though "it does nothing."
They claim to be "taking risk" but in fact they are simply "monetizing it."

The view below is in fact incorrect...and so is this article. MASSIVE amounts of capital has been expended here...and still is.

Go ahead..."value Facebook for me."
And that's just a media company with 500 employees.

Try Amazon.com..."just another media company" only with over a million employees.
That thing is bigger than the Postal Service now...and that would be OPERATIONALLY i might add.

No...i'm not putting a buy recommendation out here...just saying "shove the stupid phucking rhetoric up your ass." This is VERY real money.

I Write Code's picture

YoY charts generally suck.

But I don't deny the assertion that Capex spending is poor - in the US.  Virtually all Capex is in China.  It's that simple.

And there is no real prospect for US demand to increase, so why expand capacity even in China?  Because of Chinese demand, perhaps, but that's hardly our problem, unfortunately.

banks have not been able to revamp properly the advanced economies’ growth engines; nor do they have the tools to do so.

All the stuff that the banks (including (mostly) the Fed) have done over the past six years simply to keep the ball rolling, works against any REAL increase in growth.  The banks are on welfare, the workers are on welfare, it's all funny money and the real producers want no part of any of it.

disabledvet's picture

where is the data to back up your RIDICULOUS claim?
Is China in a huge property bubble?

Sorry but in my view a simple house on the prairie is better capital expenditure than a skyscraper. You will need energy of course...perhaps a whole lot of it actually...but go ahead...borrow against your "Empire State Building(s)"...you might not find the Banks so willing to lend to that so called "collateral."

This is why public transporation systems are so very important...that turns your "Apartment REIT" into a valuable asset because now "the occupant can get to work" (or school, etc.)

And "yet another reason why a self-driving vehicle" is of even GREATER importance. "In theory it solves the problem of public transporation" forever.

No "trillion dollar bullet trains" etc...just using existing infrastructure...all done by the private sector I might add. (Google is already doing it.) Once that "google fiber" network is deployed "nationally" they'll start running "private" public transportation networks. All run on Android Software...using any android cell phone enabled device.

And this ain't "science fiction" either...but science fact now.
great video btw.
here's one in traffic: http://www.forbes.com/sites/bruceupbin/2014/01/08/lets-go-for-a-ride-in-...
"two to three years"...yes these cars are legal in three States.

TBT or not TBT's picture

Like in the FDR era, corporations saw the Free Shit Army's demagogues were in control, so they went on a capital strike. Amity Schlaes covers this nicely in The Forgotten Man.

Today this history-ryhmes situatuon is compounded by bad demographics. A lot of old people will be shuffling off this mortal coil and there aren't enough younger ones coming up behind them to consume additional goods and services. In a lot of categories demand will slow and even drop, forcibly, so why would there be expanding capex?

NoDebt's picture

I'd say those "stingy no-capex" companies would agree with you, by their actions.  Judging by the current basement-bound situation of many 20 and 30-somethings.... I wouldn't be going long the US economy, either.  An era of bitching over how to divide the shrinking pie isn't when you double-down on production.  

Cacete de Ouro's picture

Hold on, that's six reasons from El-Erian but only five fingers. I guess this proves that you don't really need to be able to count in order to run a massive bond fund.

venturen's picture

How many corporate earning beats were on falling revenue? You hear it time and agsin they beat by 2 cents sand revenue is down 4%....that only last so long. Dollar Printing press and dollar paper stocks have been killing it though, 

Carl Popper's picture

Dividends and cash buybacks are signals from the company that they have no better use for the cash.

At least honest companies will do this. Other companies, just to fool the stockholders that the growth story is still alive, will fund reckless expansions and takeovers.

Spungo's picture

Reasons 1 through 6: the economy is FUCKED. Investing would be a giant mistake.

Flakmeister's picture

If the IOC's are giving up on CAPEX that should be telling you something more than Fed policy is at root of this...


Check out the last few slides....

RDS (Shell) can't even cover the dividend anymore....

Chuck Knoblauch's picture

Invest in trailer parks and self-storage facilities. Invest in any business that helps Americans transition into poverty.


It's Oscar night everybody!

Handful of Dust's picture

QE fed Banker Bonuses for the most part.....0.0001% trickled down to the Middle Class, Private Sector.

FieldingMellish's picture

Keep cleaning Bill's shite, Mo.

Wakemaker's picture

7) These frat boys that ran their business into the ground and were saved buy an incredible amount of printing no long believe in themselves and their ability to make wise business decisions.

This is what happens when you interrupt capitalism's cycles of weeding out of the bad players.

deki's picture

PIMCO presents real man of Genius. Today we salute you mr. PIMCO shit-cleaner-upper...

knukles's picture

If PIMCO likes its shit PIMCO can keep its shit

buzzsaw99's picture

why do capex when you can sell junk bonds instead?

Iam Yue2's picture

But didn't Hatzius and GS say that capex was going to soar? I must dig that note out.

ebworthen's picture

The FED is a corrupt evil, a silent murderer of industry:

From Shakespeare's The Merchant of Venice, 1596:

"LAUNCELOT: Nay, indeed, if you had your eyes, you might fail of
the knowing me: it is a wise father that knows his
own child. Well, old man, I will tell you news of
your son: give me your blessing: truth will come
to light; murder cannot be hid long; a man's son
may, but at the length truth will out."

Thorny Xi's picture

You can't print oil. Look at Exxon's production down 1.5% yoy. Look at the top 1100 oil fields that provide 70% of the worlds daily production, down 6.2% yoy. His point one fails to mention why there will not be continuing demand - less energy driving the industrial world. We've only known this since 1956. Bankers pay attention to long term issues. This present crop is looting what's left in the till before the store closes.

Errol's picture

Thorny, you have articulated the problem that everyone in a position of power dares not mention.  Without increase in net energy available, there will be no net "growth".  You can tinker with the distribution of the pie, but worldwide the pie IS shrinking. Whether corporations know this consciously or as a vague sense of forboding,  they do sense this remorseless reality.

Flakmeister's picture

\thumbsup for the both of you...

syntaxterror's picture

Can anybody come up with 6 reasons why this clown was pulling in $100,000,000/year at PimpCo?

Obnoxio's picture

The increasingly authoritarian governments of the West are maximising the risks of expanding businesses with their social engineering and cultural Marxist progams. Corruption and the sale of government influence to lobbyists restrains free markets from operating efficiently. Govenments also refuse to fix their large deficit spending issues over the long term so confidence in the economy will remain lower than potential.

Flakmeister's picture

Sorry, but that is basically empty ideological rhetoric...

Save it for a "Cato Institute Meet the Shill of Week" luncheon.... 

deflator's picture

el erian is a fuktard. He holds his hand up like someone who has massive calluses and experience yet it is a white as snow palmolive hand.