[OPE-L] FLOYD NORRIS Too Much Capital: Why It Is Getting Harder to Find a Good Investment

From: Rakesh Bhandari (bhandari@BERKELEY.EDU)
Date: Fri Mar 25 2005 - 14:23:52 EST


March 25, 2005

Too Much Capital: Why It Is Getting Harder to Find a Good Investment

HERE 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

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.

Copyright 2005 The New York Times Company | Home | Privacy Policy |
Search | Corrections | RSS | Help | Back to Top

This archive was generated by hypermail 2.1.5 : Sat Mar 26 2005 - 00:00:02 EST