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The financialization of Western economies, characterized by engineered low
interest rates and speculative investment in stocks, bonds, and a bewildering
array of derivative products, was an outgrowth of the shrinkage of profitable
investment opportunities in the "real" economy of plant, equipment,
infrastructure and other hard assets. Over the past three decades, the opening
of new zones of exploitation in China, the former Soviet bloc, and the old
colonial and semi-colonial sphere gave global capitalism a new lease on life by
providing it with profitable new outlets for the export of surplus capital.
Now, argue economists Michael Spence and Richard Dobbs, that surplus is rapidly
disappearing as accelerating demand from China and other emerging economic
powers begins to outstrip supply. They foresee a new era of scare capital,
higher interest rates, capital controls ("hoarding"), and a resulting slowdown
in global growth. Whatever its merits, beneath their thesis lies a familiar
ideological subtext: that governments need to "act now" to slash public
spending, lest "the fiscal deficits possible with recent low interest rates
will not be as easily financed in the future, and could result in greater
crowding out of private investment."
* * *
The era of cheap capital draws to a close
By Richard Dobbs and Michael Spence
Financial Times
January 31 2011
The global economy faces a dilemma. Attempts to boost growth have lowered
interest rates in advanced economies. The resulting hot money has moved
exchange rates out of line with fundamentals, creating inflation and asset
appreciation in the developing world. Accumulation of foreign reserves and the
imposition of barriers to inward capital flows have begun to replace tariffs
and quotas in the trade protectionism arsenals of governments.
Yet even as brewing currency wars threaten full-blown trade conflicts, we must
remember one fact: this moment will not last. The 30-year era of progressively
cheaper capital is nearing an end. The global economy will soon have to cope
with too little capital, not too much. And worries about hot capital moving too
quickly into emerging markets could soon be replaced by an era of financial
protectionism – in which governments restrict outflows of capital as a defence
against rising interest rates for corporations and consumers.
Since 1980 differences in the cost of capital in most countries have converged,
as financial markets globalised and risk premiums in developing countries fell.
Capital became plentiful, and long-term interest rates declined too – primarily
as a result of falling investment in assets such as infrastructure and
machinery. Global investment fell dramatically, creating a fall in the demand
for capital substantially larger than the growth in supply created by Asian
current account surpluses. In other words, the “saving glut” so often cited as
a cause for low interest rates really resulted from a decline in global
investment.
Today, however, this trend is reversing. Across Asia, Latin America, and
Africa, rapid urbanisation is increasing the demand for roads, water, power,
housing and factories. Global investment demand will now rise considerably up
to 2030, reaching levels not seen since the postwar reconstruction of Europe
and Japan.
The global appetite to save, however, is unlikely to rise in step, for several
reasons. China plans to encourage more domestic consumption. Spending will rise
as populations age. Even increased expenditure to address or adapt to climate
change will play a part. As a result the world will soon enter a new era of
scarce capital, and rising real long-term interest rates. Such rates will in
turn constrain investment, and could ultimately slow global economic growth by
as much as 1 per cent a year.
An era of sustained tighter capital will have significant implications.
Governments should anticipate higher costs of debt, and act now to improve
their public finances. The fiscal deficits possible with recent low interest
rates will not be as easily financed in the future, and could result in greater
crowding out of private investment.
Yet even with restrained public finances, there is still a very real danger
that governments will quickly resort to financial protectionism to insulate
their economies from rising capital costs. New rules could be introduced to
stop state-insured banks or domestic pension funds lending and investing
abroad, or to direct sovereign wealth funds to make only domestic investments.
Such moves would be self-defeating for the global economy. Real interest rates
would diverge between countries, meaning nations with big current account
deficits would suffer lower growth. Savers in surplus countries, meanwhile,
would receive lower returns too.
Governments must therefore be vigilant for early signs of capital hoarding,
while international institutions must start to develop the financial
architecture needed for a capital-constrained world. New mechanisms,
supplemented by properly regulated cross-border bank intermediation, are needed
to facilitate the flow of capital from the world’s savers to the places where
it can be invested.
New ways of financing infrastructure in emerging markets will also be
important, given their low domestic savings. Emerging economies must work to
develop deeper and more stable financial markets to develop local savings,
while mature economies should introduce policies to spur household saving (or
at least less borrowing).
Businesses will also need to adapt to a world in which capital costs more. Just
as Japanese companies with access to cheap capital in the 1980s held an
advantage over western peers, companies with access to inexpensive capital –
for example those based in high-saving countries such as China, or with links
to sovereign wealth funds – will have a new source of competitive advantage.
Financing is likely to become bundled with exports as a source of
distinctiveness, while financial institutions need to refocus their businesses
on accessing new global sources of savings.
For three decades the world has grown used to cheaper capital. But the next
stage of globalisation will be different. Governments will soon want to
stockpile capital, and efforts to boost today’s global recovery must also
anticipate an era in which capital scarcity places new brakes on growth. A
future of creeping financial protectionism would be just as destructive as
today’s currency wars. We must begin to take precautions.
Richard Dobbs is a director of the McKinsey Global Institute. Michael Spence
was a recipient of the 2001 Nobel Memorial Prize in Economic Sciences, and is
on the faculty of New York University Stern School of Business. Their report,
‘Farewell to Cheap Capital’, is published by the McKinsey Global Institute
http://www.ft.com/cms/s/0/1478bc50-2d70-11e0-8f53-00144feab49a.html#axzz1DBTM9slE
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