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  • Savings Deficit or Capital Surplus?

    Posted by David Foster on March 26th, 2005 (All posts by )

    There’s been a lot of discussion about a savings deficit in the United States. But recently, there have been several articles suggesting that the US…indeed, the entire world…now has a surplus of capital, and that this surplus is pulling down rates of return on investment. (In actuality, supply and demand of capital will always be equal, of course: the question is at what price level…in terms of returns on investment…the supply and demand curves will intersect.)

    Floyd Norris makes the capital-surplus argument in The New York Times (3/25). As evidence, he makes these subsidiary arguments:

    1)There are low rates of return on debt instruments, and long-term rates have proven to be “sticky”
    2)Stock prices are high relative to underlying valuations
    3)Countries defaulting on debt have been able to get away with it (he specifically mentions Argentina) implying reduced relative power on the part of owners of capital
    4)Increasing management compensation levels, which he believes make the same point about relative power (in this case, of managers vs owners of capital)

    These seem like good arguments, except for the last, which feels like a stretch. I’d also observe that many corporations are carrying considerable amounts of cash on their balance sheets, which they’d be unlikely to do if they were seeing lots of compelling opportunities for investment.

    But on the other hand….

    Here’s a report from the American Society of Civil Engineers, providing a “report card” on the state of U.S. infrastructure (highway, rail, electricity generation & transmission, drinking water supply, etc) and asserting that an infrastructure investment of $1.6 trillion is needed. I’d take this report with a bag or two of salt, given that civil engineers tend to benefit from projects of this nature (and I also observe that the ASCE report seems to have a pretty strong slant toward solutions involving a heavy role for govenment.) However, there’s no question that there are a lot of infrastructure investment needs, and even if the ASCE number is too high by a factor of 2X….$800 billion is still a pretty good chunk of change.

    Also: as nations like India and China continue their growth, they will absorb increasing amounts of investment. They will also drive investment requirements on the part of supplier nations: for example, for mining and for shipbuilding. If things go well in newly- or potentially-democratized nations (Iraq, Lebanon), this is likely to bring on an era of economic growth for those countries, with consequent capital demands.

    There are also heavy investment needs in the oil and gas industries: new rigs, new refineries, new tankers. Some of the technologies with promise for reducing our dependence on imported oil (like coal-to-liquid) are also likely to require considerable amounts of capital when they reach the deployment phase.

    So…is there really a capital surplus? If so, is it only temporary, and how long before the balance swings back the other way? Are there structural factors which are keeping capital from flowing where it needs to flow, and if so what can be done about them?

    Discussion is encouraged.

     

    12 Responses to “Savings Deficit or Capital Surplus?”

    1. jaimito Says:

      The vast amount of venture capital searching good ideas to invest in is an indicator of too much capital chasing too few investment opportunities. Also the high prices Israeli startups are sold to American & European corporations, shows a lack of promising projects. The situation can be described as too many hardworking dumb people working too much in a too peaceful era vs a dearth of clever entrepreneurial people.

    2. Ric Locke Says:

      There are three forces operating here, and they dovetail to form a nearly impassible barrier.

      First is the hostility exhibited by many, if not most, of the supposed “environmentalists” and “progressives” to any form of development. Reading their apologias it’s hard for me not to come to the conclusion that their real objection is that they see it as a zero-sum game: if Africans are well-fed and prosperous, Europeans cannot be.

      Second is the bog-standard resistance of the Left to anyone actually making money, especially return on capital. There’s nothing new about that, of course, but it fits perfectly with the first thing.

      And third is the (fairly recent) requirement that enterprises not merely make money, but make the most money in their category. A decent return on investment is not sufficient; they have to win, and won’t go for anything that isn’t “best possible.”

      The result is that business executives are far more ready to game the stock price than to actually invest in anything. It’s safer, doesn’t expose one to Leftist criticism, and keeps it all within a small circle of acquaintances. So there’s plenty of capital around, but none of it gets utilized for anything useful to society as a whole.

      Regards,
      Ric

    3. ArtD0dger Says:

      Hmm. My under-informed hypothesis has been that civilization has been UNDER-capitalized throughout most of its history. I would say that historically, humanity toils unproductively with inadequate tools, and that this relative scarcity has artificially inflated the significance of capital both economically and politically. Marx’s violent fixation on the “means of production” and all that rot. Capital, being the limiting factor, makes an economy flourish like fertilizer makes crops grow simply because economies are almost always starved for capital.

      Aside from the upheaval of coming to a new equilibrium (which looks to be considerable, admittedly), what is so bad about a capital “surplus?” Those willing to produce have easier access to the tools they need to be productive, be they technical entrepreneurs or low skilled laborers. Sure, investors will have to be that much more involved and educated in their holdings in order to make a buck, but wouldn’t the new situation alleviate many of the complaints our left-leaning friends have about capitalism in general?

      I would think that an excess of capital would paradoxically take the “capital” out of capitalism. It would shift the balance of power away from owners and towards producers. It could generally be more productive and egalitarian, while at the same time remaining market-driven, decentralized, and free.

    4. David Foster Says:

      ArtDodger…some interesting points. Bear in mind, though, that the same indiviual may be a “producer” and a “capitalist” at different points in his life…a producer during his peak earning years, and a capitalist after retirement. To the extent that the capital surplus is real, lowered investment returns will make the retirement issues in the U.S. and elsewhere much more difficult.

    5. Ken Says:

      There’s never a shortage of useful work to be done, and useful tools to build. It’s usually a question of whether people are allowed to make money by doing the work and building the tools.

      In the so-called Robber Baron era, you could build pretty much anything you wanted, offer it to the public, and make a fortune if they went for it. Nowadays, vendors in most industries are strictly limited in what they may sell by regulation, and potential customers in most industries are similarly limited. Outside of electronics, computers, and the arts, there are few new things that someone could come out of left field with and put on the market without playing years of Mother May I, and perhaps more important, every step of the process of incremental improvement is similarly hobbled.

      It’s not surprising that we’ve wound up with depressed return-on-investment for venture capital.

    6. Lex Says:

      I’m with Ken. The opportunities which seem to be realistically within our grasp are greater than our ancestors could have dreamed of, as he has repeatedly pointed out on this blog. The obstacles are not technological, but political and legal, and therefore theoretically subject to change. The problem is that the stakeholders in the status quo are very powerful.

    7. Ginny Says:

      I believe this reinforces Ken & Ric’s arguments: Googling for the note on Borlaug, the following argument came from a supporter (but detractors also pop up in such searches):

      Borlaug . . .thinks famine will only be stopped when poor countries develop their own high-yield crops, use chemical fertilizers and genetically enhanced crops, and nurture regional food economies. The best target for charity is not buying food from rich countries and sending it to poor countries but making poor countries self-sufficient by helping them use high-tech agricultural science.Amazingly, a large coalition of European and American organizations actively oppose Borlaug’s ideas for poor countries with starving peoples. Organizations such as Jeremy Rifkin’s “Pure Food Campaign” see the scientific techniques of modern agriculture as the evil knowledge of international agribusiness. Such organizations want instantaneous, egalitarian land reform combined with organic farming to create self-sufficient, eco-tourist-friendly countries. Even though genetically enhanced golden rice (rice containing a bit of carrot) could get vitamin A to African kids and hence prevent thousands from going blind, Greenpeace and the David Suzuki Foundation oppose planting such rice..

      Other pieces discussed his difficulty getting funding for later projects. Of course, making land more productive also leads to less soil erosion, fewer acres feeding more people – you know, those things that should make environmentalists happy, but don’t, somehow.

    8. ArtD0dger Says:

      David – I certainly agree that the black-and-white distinction between “producer” and “capitalist” is counterproductive. Heck, I’ve been trying to slowly transition to the latter class throughout my adult life.

      But it seems to me that you are arguing from need rather than economic fundamentals. If the verdict of the market is that the relative worth of capital has declined, then we must either accept that verdict and work with it, or we must engage in the sort anti-market interventionism that had such a sad history throughout the 20th century.

      If, as Ken and Lex assert, we decide that market signaling mechanisms have been corrupted by government interference, we must find very strong evidence and arguments to make that case. Such a stance will surely raise the hackles of those who are not predisposed to believe in market economics. They will charge hypocrisy for preaching free markets and then rejecting market valuations when they are not to our liking.

    9. Rahul Says:

      Ginny: I think that quote meant to say ‘drought’ not ‘famine’.

      While I don’t agree with a lot of what Nobel Laureate Amartya Sen believes, his most famous piece of research does seem to stand true – famines rarely take place simply because of a shortage of food.

      Moreover, famines only occur in despotic, non-representative governments. In all of human history, droughts in representative governments have never turned into famines. The reason being, representative governments care enough about their countrymen to organize relief efforts in drought periods, contrasted to despotic governments like the Brits in India who really didn’t care enough about the famous Bengal famine of 1943, which killed approx 3 million people. And of course, China’s crazy communist policies that caused the famine of 1958-61, killing between 28 and 30 million people.

      Note that India hasn’t had a famine since independence, but has faced several droughts, contrasted to Africa, which always seems to have numberous famines over the decades, and despotic governments to match.

    10. Financial Rounds Says:

      Savings Deficit or Capital Surplus (From Chicago

      David Foster at Chicago Boyz asks the question, “Savings Deficit or Capital Surplus”:

    11. David Foster Says:

      WSJ (3/23) has an article by Jeremy Siegel touching on this topic. Referring to India and China, he says: “As these Asian countries grow, their markets will become more liquid and their currencies more convertible. Bondholders in developed countries who are unhappy with the return on their domestic bonds will be drawn to these foreign powerhouses, lifting rates throughout the developed world. Faster productivity growth will in turn increase the return on equity capital and support higher stock prices.”

      As evidence that such growth is possible, he cites the following: “Over the last 40 years, Japan went from 20% of US per capita income to 96%/ Hong Kong from, 16& tp 70%, and South Korea from 11% to nearly 50%.”

    12. AnotherScott Says:

      I’m a real estate developer/contractor. In the Chicago area the market has grown incredibly effecient because so many people are looking for deals that it is almost impossible to find anything unless you are privy to it before it is put on the MLS (multiple listing service). Likewise, if you go higher up in price and size all the REIT and Fund money out there has pushed prices up and profit margins down.

      Funny thing is, I went to Kellogg’s Private Equity Conference a couple of weeks ago and I heard the same thing. Too much money, not enough deals.

      I expect a couple of things to happen. In the larger scale of things, peoples risk aversion will drop as they search for deals and money will start going to terciary markets, both within the U.S. and abroad.

      Also, the market could change. The rise of interest rates could cause a bursting of the bubble in some markets (suburban houses, high-rise condos, other condos). This could cause a broad scare away from the real estate market as the less expert investers get the jitters. [I'm actually kind of hoping this will happen and create some good deals for me].

      Finally, I might add that I see part of the reason for the surplus of capital is a high risk aversion. I think people are looking for sure things and we are still recovering from the shocks of the dot.com burst, 9/11, and the wars; atleast in matters of perception.