Are we really there yet? That’s the question the world’s investors, economists and asset managers, to name a few, have started debating – as to whether we have reached the point in the economic recovery where businesses are about to start meaningfully investing in their businesses, rather than hoarding capital.

In fact, as many have noted, U.S. companies outside of the finance industry are holding more cash on their balance sheets than ever, with 1.64 trillion at the end of 2013; that’s up 12 percent from the prior record in 2012, according to Bloomberg. If these firms were to begin deploying this capital (known as capex) this would have a meaningful impact on the economy, contributing substantially to increased economic growth going forward, and thus inflation over time.

Of course, every year since the 2008 financial crisis, predicting the resurgence of capital spending by companies has proved an elusive target for the world’s economic forecasters. The recovery in corporate spending always seems forecasted to be one quarter away – and then fails to materialize. And businesses themselves have been vocal about the lack of demand or the weakness in the economy as the chief reason that they have kept money on the sidelines.      

Chart A: Is a Jump in Corporate Spending in the Making?

But a number of investors say things now are really different. They point to materially improved U.S. economic growth, increased hiring, increased consumer spending and a resurgence of manufacturing. In fact, whereas investors penalized companies for increasing capital spending, now they are being rewarded.  According to a Bank of America Merrill Lynch report, investors are demanding that companies invest in growth instead of using their cash for buybacks, dividends or balance sheet repair.

Particularly as firms that have achieved lofty valuations through buybacks are starting to underperform as many of these firms’ earnings forecasts do not substantiate the high valuation. BofAML’s global fund manager survey suggests that 58% of investors currently prefer capex to other forms of cash deployment  – a record high in the history of the survey data. 

One fund manager at Nuveen Asset Management, according to a recent research note, believes the U.S. cyclical recovery will be bolstered by three factors, namely: 1) Federal Spending is expected to rise more than 1% per year; 2) Personal Consumption should improve since the underlying labor market seems healthy, with higher unemployment data and lower initial unemployment claims and; 3) Capex could soon be required as companies need to invest in new capacity to meet rising demand for products, since capacity utilization is increasing.

And it is this last point – capex – that along with increasing labor and government spending – could make all the difference in supporting a sustainable recovery. But again, how to be sure that companies really are genuine about an increase in spending this time around?   

The Ultimate Inflation Metric

Economists measure economic slack in three major ways, as you may know. Perhaps the most common measure is the unemployment rate, which measures unused resources in the labor market. Another measure of slack is the real output gap, the estimated difference between actual real output and the economy’s potential output. The third major measure of economic slack is the capacity utilization rate, which can give major insights into corporate capital spending plans.

The capacity utilization rate measures the operating rate of the nation’s industrial capacity. In fact, most economists believe the capacity utilization rate is a useful indicator of inflationary pressures. Historically, capacity utilization in the manufacturing sector has tightened before the rate of consumer price inflation has increased.

Moreover, displayed as a percentage, capacity utilization levels give insight into the overall slack that is in the economy or a firm at a given point in time. If a company is running at a 70% capacity utilization rate, for example, it has room to increase production up to a 100% utilization rate without incurring the expensive costs of building a new plant or facility.

But as the slack in the economy diminishes, firms typically face higher production costs in order to raise the output further. The higher production costs would usually be passed through to the ultimate purchaser as higher prices of finished goods. Inflationary pressures can be judged by comparing the current capacity utilization rate with an estimated stable-inflation capacity rate. 

Past economic research has found that the stable-inflation capacity utilization rate in the manufacturing sector was 82 percent. According to the Federal Reserve Bank of St. Louis, today capacity utilization is at 78.6, substantially higher than it was a few years ago, and an indication some say of imminent increases in capital spending. But others are not so sure.

According to a research report by Morgan Stanley in early May, “capacity utilization is below the long-term average for the vast majority of industries and none are at peak level,” adding that they did not see any areas where utilization levels are high enough to merit a big pickup in capital spending.

In fact, the report points out that consensus forecasts for capital spending to sales are modestly lower in 2015 and 2014. Presently, capital spending remains about 30 percent below the average improvement in the prior five recoveries.

Then, from where, one might ask, has the expectation that capital spending would improve, if there is no indication that capacity utilization rates warrant an increase in corporate spending as there is still much spare capacity in the economy? 

Those who do feel that corporate spending is on the upswing point to ever-increasing manufacturing and business sentiment indicators; comments by executives reporting first-quarter earnings that they would be increasing spending are at their highest since January.

Further, these corporate spending bulls point to the latest report on industrial production and capacity utilization from the Federal Reserve that shows that the capacity utilization rate increased in March to its highest level in almost six years.

Certainly, whether one believes companies are about to increase their capital expenditures imminently or not, what is clear is that the capacity utilization rate is high enough to invite a significant amount of speculation on the subject.

And whether it happens this year or next (as most economic forecasts still predict a modest, slow recovery), what is certain is that we have arrived at the beginning of the beginning of the corporate capex spending cycle and investors should begin watching capacity utilization rates closely, as at some point the slack will tighten enough to bring on inflation once the economy begins growing at a faster clip.