In which Myriam finds our financers are awash in cash, and why that’s a problem.
$600 trillion. That’s the value of the financial economy, or it was in 2010, according to a new report by private equity fund Bain Capital, ‘A world awash in money’. It’s ten times as much as the value of everything the whole world produces in a year.
You’d think the global financial crisis would have destroyed plenty of financial wealth, but the financial economy has rebounded a whole lot quicker than the real economy has. Since the GFC, world output of goods and service (you know, stuff) has barely grown. However, the volume of financial assets (financial holdings, the balance sheets of banks, the value of financial instruments) continued to grow, fast.
“The expansion of the financial sector has accounted for an increasing share of world economic growth for years,” Bain’s report states. “The shift began with the end of the Bretton Woods system in the early 1970s and has accelerated since the 1980s with the advent of financial engineering, computing power and regulatory changes that reinforced it. The steady, decades-long build-up of financial capital has masked the fact that real economic growth was slowing.”
This isn’t great for people who want to invest money, which is what Bain is concerned with.
“The most immediate effect [of capital abundance] has been to paralyze, confuse and distort investment decisions.”
In good economic times, people who have capital (money) look for things to invest in that’ll give them a good risk-adjusted rate of return. This sets up a virtuous cycle – good investments grow GDP which gives investors profits which gives them more money to invest. But if there’s more money than there are things to invest in, that pattern of wealth creation doesn’t work as well.
So what are investors doing now? Partly, they’re sitting on their money, much to the detriment of national economies desperate for investment. And when they’re not doing that, they’re investing in bubbles which offer them a way to make a quick return on investment.
With more money to throw into them, asset bubbles are getting worse, Bain says.
The chart that opened this post (click on it to enlarge) makes this point. The line represents world GDP growth. You can see why the GFC has been the worst thing to hit the global economy in decades.
The worrying thing is if the private equity fund is right, too many financial assets are exactly what cause investors to recklessly plough their money into asset bubbles in the first place.
As long as financial assets keep growing, and investors keep doing what they’re doing, we haven’t seen the end of the economic turmoil that’s characterised the start of the twenty-first century.