Midyear Investment Review and Outlook : A Global Quest for Cash : Growth: Is there enough capital to go around? Some think not--and say a looming shortage explains a great deal.
Before so much of the world decided to go capitalist, someone should have asked a simple question: Is there enough capital to go around?
With 1994 half over, financial markets are already fixated on next year. And the global economy that some investors now envision in 1995 is one that will be trying to fire on all cylinders, only to find that the necessary fuel--capital--is in woefully short supply.
The prospect of a planet full of eager entrepreneurs and road-and-bridge-building governments all bidding for scarce resources--including money--to realize their dreams of growth is the dark cloud overhanging world financial markets today, these analysts say.
A looming capital shortage, this school argues, explains why long-term interest rates remain absurdly high relative to current low inflation. It also explains why prices of “hard” resources (in the form of many commodities) are rising, and why investors are fleeing the currencies of some of the most capital-needy countries, such as the United States, which could be most vulnerable in a time of short funds.
The issue is not so much whether money and resources will be available to fund a global economic expansion in 1995, these experts say, but at what price , and therefore with what consequences.
“Any given price (for capital) will clear the market, but it’s not at ‘any price’ that economies can grow,” warns Kenneth S. Courtis, senior economist for Deutsche Bank Capital Markets in Tokyo.
If too many would-be capital users are priced out of the market, the great promise of the post-Cold War world--that free markets would raise living standards for all--may vaporize.
More important for the average American, a global capital shortage could finally bring home the painful cost of the nation’s towering budget and trade deficits--and significantly change the outlook for investing here and abroad.
*
The idea of a global capital shortage first surfaced when the Berlin Wall fell in 1989, heralding the breakup of the Soviet Union and the beginning of the end of rigid communism worldwide. Some economists wondered aloud about the cost of suddenly integrating the so-called First, Second and Third worlds under the capitalist-consumerist banner.
But before the world economy could lift off in the new era--and with it, the worldwide demand for money--Iraq invaded Kuwait in August, 1990.
The subsequent Gulf War, coupled with a bursting of the real estate and financial bubbles in Japan and a massive corporate restructuring campaign by American companies, produced recessions so deep and long lasting in the United States, Europe and Japan that the developed world’s need for capital was significantly muted.
In the United States, for example, private credit demand dwindled so markedly that the Federal Reserve Board was able to cut short-term interest rates to 30-year lows by last year, pulling long-term rates down as well. Those lower rates, in turn, helped businesses and consumers rebuild their balance sheets and set the stage for a new economic expansion.
Now that expansion is in full swing in the United States. And to the surprise of many economists, Europe too is rebounding, and Japan appears ready to follow.
In the meantime, the bulk of the developing world--China, India, Southeast Asia and Latin America--has been growing at a brisk pace since 1991 and is counting on new growth in the industrialized nations to further its own economic advance. Even in troubled Africa, the emergence of a free South Africa is expected to provide a catalyst for economic improvement.
David Hale, economist at Kemper Corp. in Chicago, points out that the world’s capitalists have waited 80 years for this. “For the first time since 1914, practically all of the nations on this planet have market-oriented economic systems,” he says. And in 1995, virtually all of those individual economies should be growing synchronously for the first time.
Or trying.
*
Hence the capital-shortage conundrum: A planet swarming with capitalists will require money and resources at a level never before witnessed. Some of that increased demand is already visible; much is admittedly theoretical, if quite logical:
* In the United States, outstanding commercial and industrial loans at banks, which plunged from $640 billion in early 1991 to $585 billion by the end of 1993 as businesses paid down debt, have been rising almost nonstop this year. With corporate borrowers again stepping up to the window, the loan total has already climbed back to $609 billion.
* Privatization of state-owned enterprises--through stock offerings that suck up available capital--continues in full swing in China, the former Soviet Union, Eastern Europe and Latin America. And those developing nations now have been joined by capital-short Western governments struggling to streamline their own economies.
France, for example, is in the midst of a five-year plan to raise $78 billion through stock offerings in state-owned firms such as drug giant Rhone-Poulenc. A privatization program is also under way in Italy, where the government raised $3.1 billion just last week by selling a 51% stake in insurance company INA to public investors.
* In East Asia, the money needed to develop the fast-growing region’s inadequate infrastructure alone could total a stunning $1 trillion over the next six years, according to John Lonski, economist at Moody’s Investors Service in New York.
For instance, Taiwan is in dire need of more power plants, Lonski says. “Electric power now must be rationed during the summer months because of (power-generating) reserve margins that border on the anorexic”--typically, a mere 5% over normal usage, he says.
* In one of the biggest market surprises this year, the prices of many commodities have surged as rising demand from growing economies has suddenly revealed relative shortages of worldwide staples such as coffee and cocoa.
William Gross, managing director of Pacific Investment Management Co. in Newport Beach, sees the commodity revival as a byproduct of the developing world’s rapid ascendance as an economic force.
“The developing world was known in previous decades as the provider of commodities for Japan, Europe and the United States,” Gross says. “Now they will be using an increasing amount for their own growth, and prices will have upward momentum.”
*
It is that accelerating competition between the developed world and the developing world that is the root cause of the coming capital shortage, analysts say.
The mature economies of the Western world should be at a stage where they are supplying capital to the developing world, where growth is faster--and where, therefore, investment returns should be higher.
In fact, the West has exported vast amounts of capital to developing countries. In the 1970s, for example, there was massive (and ultimately disastrous) lending to Latin America by U.S. banks.
Today, Western investment in developing countries is booming again, and this time it is more direct, often in the form of equity. Nowhere was that more evident than in the frenzy U.S. investors demonstrated for “emerging market” foreign stocks last year.
In the 12 months ended March 31, assets in the emerging-market category of stock mutual funds skyrocketed from $918 million to $6.7 billion, according to fund tracker Lipper Analytical Services in New York.
While the West was growing slowly or not at all between 1990 and 1993, capital exports to the developing world were no great concern, and even were encouraged. Now, however, the question increasingly being asked is whether the West can retain enough capital to finance its own needs in 1995, as the United States, Europe and Japan grow.
What troubles many experts is that the West’s propensity to generate savings and investment capital is dwindling, even as the demand for money within its own economies--let alone those of the developing world--is set to soar.
Deutsche Bank’s Courtis, who has lectured extensively on global capital flows, calculates that the so-called G-6 Western economies (those of the United States, Germany, Britain, France, Italy and Canada) saved a net 13.8% of their gross domestic product during the 1960s. The G-6 savings rate fell to 12.7% in the ‘70s, 8.1% in the ‘80s and now is 7.8%, Courtis says.
At the same time, a chorus of critics say, the West has been spending too much. The monuments to that imbalance, of course, have been America’s twin deficits--budget and trade--which have ballooned for two decades.
So far in the ‘90s, Germany and Japan, among other developed nations, have also found themselves increasingly preoccupied with burdensome internal spending issues.
In Germany, the absorption of the former East Germany caused the federal government to run a budget deficit equal to 4.8% of GDP last year, compared to a 0.1% surplus in 1989.
In Japan--long the world’s most important net capital exporter--the bursting of the bubble economy has forced many institutions to repatriate foreign-held wealth in order to deal with a liquidity squeeze at home. In effect, the plunge in Japanese real estate and stock values has acted as a giant margin call.
Combine a global economic expansion in 1995 with a declining Western savings rate and unprecedented financial needs in the capitalist developing world, Courtis argues, and the result is likely to be “sharply increased tensions in world financial markets.”
*
The first tangible sign of those tensions may have appeared on Feb. 4, when the Federal Reserve Board began to tighten credit for the first time in five years.
Ostensibly, the Fed has raised short-term interest rates to slow the U.S. economy and thus keep inflation under control. What higher short-term interest rates also do, however, is encourage Americans to keep more of their money at home instead of sending it abroad--and to keep it in short-term savings accounts rather than in true long-term investment vehicles such as stocks and bonds.
Had the Fed deliberately wanted to husband liquidity that would be readily available to fund a growing U.S. economy, it could make no better move than to raise short rates.
Not surprisingly, global stock and bond markets have been in turmoil ever since the Fed acted.
Perhaps the biggest shock to markets worldwide has been the rise in “real” interest rates, as measured by long-term bond yields. In the United States, the yield on the benchmark 30-year Treasury bond has soared to 7.6% from 6.35% on Feb. 4.
Yet the prospects for inflation, which theoretically determine long yields, have remained tame by virtually all accounts; U.S. consumer prices are expected to rise only about 3% this year.
That means the after-inflation yield on long-term bonds now is about 4.5%, a historically gigantic premium.
What is causing such high real interest rates? The unwinding of excessive speculation in bonds last year is part of the answer, many analysts say; speculators who had bought bonds with borrowed money last year, betting on a continuing slide in yields, have been forced to bail out of their bets this year. That has increased the supply of bonds for sale, forcing prices down (and thus yields up).
But some experts see something more fundamental at work: The markets, they say, are recognizing that demand for money will be rising powerfully worldwide in 1995, so the price of that “commodity” is going up.
Pacific Investment Management’s Gross, among others, has been warning his clients that the world economic outlook “suggests a higher level of real interest rates (ahead) than in prior decades.”
Edward Leamer, professor of economics at UCLA’s Anderson business school, cautions against viewing the concept of a global capital shortage as an instantaneous event, but he nevertheless draws the same long-term conclusion as Gross: “I see a slow, general increasing trend in real interest rates,” he says, as more borrowers compete for scarce dollars--or yen or marks or pesos.
*
If the idea of a global capital shortage is hard to grasp, the pain of high real interest rates is not. Should long-term yields stay high worldwide, the effect will be similar for the home buyer in Anaheim, the entrepreneur in Bangkok and the multinational corporation in Berlin: All will have to work harder to meet debt payments and make ends meet.
High real rates also change the equation for world stock markets--which is a large part of what is troubling the markets this year, many analysts say. Higher interest rates are a natural depressant on stock prices and inevitably make investors far choosier about the stocks they will buy, because expected returns must be high enough to compete with better yields on bonds and bank CDs.
Ironically for the West, increased discretion on the part of its well-heeled investors may exacerbate the impact of any capital shortage in the developed world, for a simple reason: If the developing world continues to grow at a faster pace, investment returns there should follow, which should keep money flowing into those markets. That’s an argument for American investors to own more emerging-market stocks in the ‘90s, not fewer.
Indeed, the most surprising aspect of a global capital shortage in the ‘90s may be who wins and who loses--that is, which countries wind up less short than others.
Deutsche Bank’s Courtis contends that the clear winner will be East Asia, for a very simple reason: If capital creation becomes paramount, the countries that have the highest savings rates and the lowest labor costs will find it easier to fund their own growth. And no countries generate more internal savings than the nations of East Asia, including China, Taiwan, South Korea and Thailand.
Consider: In 1981, just 14% of global central bank reserves were in Asia, including Japan, according to Courtis. By 1992, that figure had reached 43%.
In contrast, the United States--with its dismally low savings rate and monolithic deficits--is in increasing danger of losing its post-World War II ability to dictate the terms of its growth, and the world’s, Courtis warns.
The latest battle to prop up the dollar, he and other economists say, is merely a symptom of a larger problem, which is that America is already beholden to too many foreign creditors. Foreign and increasingly powerful creditors.
The inevitable result of the ‘90s capital shortage, Courtis contends, is that “the money that North America and Europe need will increasingly be set on terms and conditions determined in Asia. I think this is going to be the story in the markets over the next few years.”
The Case for a Capital Shortage
Some analysts say a shortage of capital--the result of economies growing on almost every continent--explains much of what is ailing financial markets worldwide. That includes stubbornly high interest rates, soaring commodities prices and the weak U.S. dollar.
*
THE DEVELOPING WORLD’S HUNGER FOR CAPITAL IS VORACIOUS . . .
Net capital inflow into developing countries, average annual sum in billions of dollars:
*
1976-1980: $15.8
1981-1985: 40.9
1986-1990: 37.4
1991: 126.4
1992: 143.0
1993: 159.5
*
. . . BUT JAPAN IS BEGINNING TO EXPORT LESS CAPITAL . . .
Net capital outflow from Japan, average annual sum in billions of dollars:
1976-1980: $0.3
1981-1985: 23.0
1986-1990: 63.9
1991: 90.0
1992: 118.9
1993: 108.0
*
. . . AND THE WESTERN WORLD’S SAVINGS RATE--AND HENCE ITS AVAILABILITY OF CAPITAL--IS PLUNGING.
*
Net Savings rate, as a percentage of gross domestic product, for G-6 countries:
*
1960s: 13.8%
1970s: 12.7%
1980s: 8.1%
1990s: 7.8%
*
Note: G-6 includes the United States, Germany, Britain, France, Canada and Italy. Figures are the averages for each decade. Figure for the 1990s is the average through 1993. Changes in net official monetary positions are excluded.
Source: Bank for International Settlements; Deutsche Bank Capital
