March 25, 2005
Too Much Capital: Why It Is Getting Harder to Find a Good Investment
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
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.