08 August 2016

Post-Capitalist Economics: What It Means for Policy When Investors Buy Negative Interest Rate Bonds

$10 trillion around the globe is now invested in negative interest rate bonds. Investors are actually paying countries to keep their money, the way that you might pay a bank for a safety deposit box. The Netherlands has records that go back 499 years - back to the year that Martin Luther started the Protestant Revolution - and for the first time in half a millennia, the Dutch are paying negative interest rates on bonds. Japan, the European Central Bank, Sweden, Switzerland, and Denmark are all paying negative interest rates on some bonds. The price of capital is really, really low.

Prices fall when there is a glut. All together, there is more than a quadrillion in money, precious metals, stocks, bonds, and financial derivatives. As the global population grows and - more importantly - the number of people earning enough to save grows - the supply of capital continues to grow. The US alone has more than 10 million millionaires and now has more billionaires than members of congress.

The supply of capital is at an all time record high. That's reason enough that capital's price (interest rates) is low but there is more. The demand for capital is low.

What options do investors have? There is real estate, which continues to rise in major cities. And obviously you can buy bonds - an increasing percentage of which offer a negative interest rate. Or you invest in existing businesses, buying stock. Stock might look like a decent investment compared to bonds, but stocks are priced pretty high already. And companies have enough capital that they are buying back their own stock at record rates. They don't really need your money and don't even know what to do with their own cash. Another option is to fund a startup rather than buy stock in an existing company. You can help to create a business rather than just buy a share of an existing one.

So, what is the demand like for startups? How much capital do they need? Not much. It now takes less capital to start a business and that is one more reason the price of capital has fallen.

The Global Entrepreneurship Monitor (GEM) tracks various entrepreneurial measures around the globe (which I guess is implied by its name). One fascinating tidbit came out of new data they released 8/8/2016. In their 2006 report, entrepreneurs needed an average of $65,000 to get a business off the ground. For the 2015 GEM report, the median was $13,000. Now median is typically lower than average and it is possible that the difference between $65,000 and $13,000 could all be explained by that difference in measure. It's also possible that the capital needs for startups has dropped considerably in the last decade.

To exaggerate the differences, think back to a startup in 1960 when you might be setting up a factory or even a brick and mortar store. That requires a serious outlay of capital. Now think about a startup today. It might be focused on app development. They might need a half dozen laptops for the programmers.

Consider Uber. Its valuation is around $60 billion. It is essentially a taxi service. It has at least a quarter of a million drivers in the US but it didn't have to purchase any of their cars. 10 or 20 years ago, it might have taken $5 billion to create a fleet of 250,000 taxis. Today they are able to "create" a new car simply by having another driver download an app. The capital it took to start Uber is so much less than what it would have taken to create comparable capacity in 1995 or even 2005 before smart phones became ubiquitous. Uber was able to create a lot of wealth but they didn't need a glut of capital to do it.

In 2006, it took $65,000 to start a company. By 2015, it took maybe 1/4 that. Demand for capital is dropping even as the supply of capital is going up. No wonder the price of capital is so low.

There are a couple of implications of this.

One implication is that capital is no longer a limit. To have low capital gains tax might make sense in terms of competing for global capital but it doesn't make sense in terms of trying to attract capital as if it were still the scarce input that it was in the late 1800s - or even late 1900s.

The other implication is that we have to think about strategies that treat capital as plentiful rather than scarce. What does this mean? Among other things, it means that we should more aggressively fund startups, recognizing that it is the entrepreneurial opportunities that are scarce rather than the capital to fund them. And of course if we go further upstream, we will realize that the entrepreneurial opportunities worth investing in are more scarce than we would need to fully employ capital because we don't do enough to create entrepreneurs. We have an education system designed to create knowledge workers but not to create entrepreneurs. And entrepreneurs - rather than capital - are the real limit to today's economy. We have to popularize entrepreneurship.

For roughly the quarter century leading up to the Great Recession, excess reserves bounced around between one to two billion dollars. Excess reserves are money that banks keep rather than loan out. Then starting in September of 2008, excess reserves began to swell. From August to September, they rose from %1.9 billion to $59 billion. In October they hit $267B and then $767B by the end of 2008. In August of 2014 excess reserves peaked at $2.7 trillion, roughly 200X what they’d averaged before the Great Recession.
You have to appreciate the fact that the Federal Reserve was trying to pump capital into the economy. The fact that it did so much more for excess reserves than actual investments suggests that capital wasn’t the limit to progress. (An important caveat here. At the height of the financial crisis in 2008 and early 2009, credit and capital was a limit and it was a beautiful thing to have the Fed intervene with a flood of cheap capital and guarantees. By 2014, though, things were a little different.)
Policy makers continue to act as though capital is what we need more of and we use everything from tax policy to monetary policy to address that apparent scarcity.

The question is no longer, How do we get more capital? We've got a glut. The question is, How do we get more entrepreneurs and make more employees more entrepreneurial? We've got plenty of capital to fund them. So much capital, in fact, that we're putting it into negative interest bonds. That might be a signal that we need to start treating capital differently. This is a post-capitalist market economy and requires a different set of policies.

One reason that markets are great is because of price signals. Things that are cheap you should use a lot of and things that are expensive you should use less of. Capital? Capital is cheap and we should take the market's advice on how to use it. What really is scarce? The entrepreneurial ability to transform that capital into jobs and wealth. That’s the limit that policy should focus on overcoming.

1 comment:

Bald Al said...

"Capital is cheap and we should take the market's advice on how to use it. What really is scarce? The entrepreneurial ability to transform that capital into jobs and wealth."

I would relate the 3rd sentence in the above excerpt is exactly the crux of the situation in that my observation is those w/capital seem only interested in short term gains. It appears the days of incubation are long gone. It's as if the entrepreneurial lending cycle is similar to electronic communication: immediate returns. Just as so many people are always connected and want information instantaneously, it seems as if those lending out capital to entrepreneurs want instant return on their investment.