The Investment Drought

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Via Tyler Cowen, a guy who goes by the handle “Phone Booth” offers this take on the global savings glut and the great financial meltdown:

It wasn’t that the world was saving too much relative to the past and the uncertainties of the present. Instead, low long-term interest rates were caused by the lack of demand for savings. This lack of demand for capital is, of course explained by the lack of investment opportunities.

….The whole crisis makes perfect sense if you start with lack of high [return on equity] investment opportunities in the world as a whole, with local markets struggling to incorporate this information appropriately. To institutional investors, ranging from pension funds to insurance companies, fixed income investments appear disproportionately attractive in this environment, driving long-term interest rates low. Consequently, mortgage rates drop, making equity investment in housing attractive for homeowners….This temporarily cushions the blow to the economy of not having high ROE investment opportunities, by becoming the high ROE investment opportunity itself.

….[But these] investment opportunities turn out to have been illusory and cause significant losses for whoever in the supply chain is stuck with the excess inventory. The growth in supply of housing uncovers the illusion and the resulting price volatility causes a credit crisis and a severe economic downturn, as the economy faces both the temporary shock of price volatility and the long term shock of lack of high ROE investment opportunities.

And what explains the lack of high ROE investment opportunities in the first place? There are many places to look, but the biggest is the supply bottleneck in energy. While the growth in information technology has been impressive, as is the consequent potential for increase in productivity, none of this can increase return on capital against the backdrop of energy supply bottleneck. 

Years and years ago, this was the very first thing that got me worried about the U.S. economy. I hadn’t even heard of the infamous savings glut at the time (it was before Ben Bernanke invented the idea, I think) but the flip side of a savings glut is an investment drought and that sure seemed to increasingly describe an ongoing phenomenon. Corporations were hoarding cash and buying back stock instead of making investments in the real world, and that was pretty worrisome. Sure, we were just coming off the dotcom boom and everyone was a little nervous, but during an economic expansion there ought to be plenty of good opportunities to expand business and attract new customers. So why weren’t companies more bullish?

Like Tyler, I’m not sure that energy is the answer here, but then again, it’s not a bad guess either. The steady rise in oil prices during the aughts, followed by the spike in 2007-08, probably deserves more blame for the financial crisis than it usually gets. But whatever the reason, certainly one of the reasons for the housing bubble was the simple fact that real-world investment opportunites in goods and service just didn’t look very attractive. Figuring out why really ought to get more study than it has.


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