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Too Much Capital: Why It Is Getting Harder to Find a Good Investment
Published: March 25, 2005
THERE is too much capital in the world. And that means that those who own the capital - investors - are in for some unhappy times.
That thesis may sound inherently unlikely, but it explains a lot. Those with capital find they must pay high prices for investments that are likely to produce only a little income. The relative importance of things other than capital, like commodities and cheap labor, has grown.
Evidence of the capital glut can be seen in interest rates. Market rates are low, and even when central banks set out to raise short-term rates, longer-term rates are slow to move. Little additional yield is available to those who buy very risky bonds. For the same reason, stock prices are high. Profit disappointments may not cause the stock market to plunge, since the capital will have to go somewhere. But the return on the underlying investments is likely to be below what investors have expected.
With capital in a weakening position, returns that once would have gone to owners of capital have gradually been redirected. That is one way to explain the surge in management compensation in the last two decades. In the early 1980's, when interest rates were high and stock prices low, the average chief executive received no stock options in any given year. Now nearly all get sizable grants, and one study found that chief executive pay rose faster than that of any group save for professional athletes and movie stars. Those who provided the capital had less power to demand the profits from the enterprises they financed.
Another sign of excess capital can be seen in what Argentina did to its creditors - and in how they reacted. When Argentina defaulted on its debt in December 2001, many thought it would eventually negotiate a deal with creditors that was similar to previous arrangements made by countries in default. Instead, this year it imposed far harsher terms and refused to talk about them. The vast majority of the bondholders meekly went along and bonds of other emerging markets have not suffered.
Emboldened, Argentina's government is sounding an uncompromising note regarding foreign-owned utilities and oil companies. It is betting that it can get away with treating the owners of capital badly and it may be right.
Why is there too much capital? One answer is that central banks reacted to the bursting of the technology bubble by cutting interest rates by too much for too long. The resulting liquidity might in other times have sent inflation soaring, but now China's emergence has placed offsetting deflationary pressures on consumer goods prices. The excess liquidity is sloshing around world capital markets.
At the same time, China's emergence is spurring investment that the world may not need. The world automobile industry is plagued by overcapacity, but every car company believes it must have plants in China.
We have seen too much capital before, but not on a worldwide basis. It flooded into Japan in the 1980's when money there was cheap and the success of the Japanese economy obvious. Japanese business still suffers from excess capacity. Excessive investment in telecommunications in the late 1990's left a lot of unused fiber optic cable.
The excess of capital is bad news for wealthy economies, especially as it is happening when aging populations in Japan, Europe and the United States need good investments to finance retirement. But it should be good news for economies that need capital to develop.
Capital will not remain in excess forever. Money will be spent on consumption rather than investment, and new technologies and rising demand will eventually create more uses for a supply of capital that will have been depleted as low returns discourage saving. But for those with capital, that could be a slow and painful process.
http://www.nytimes.com/2005/03/25/business/25norris.html?