The World Does Not Need More Capital, It Needs More Income

This time it's different? Yeah, and I can also offer you a great deal on real estate in Florida, China, Ireland, Spain...

Old habits die hard. Most of the western economies have become dependent on finance the way the Kardashians have become dependent on celebrity: it may not produce much value but it's what they know and they don't have any other ideas.

The world does not lack for capital. Getting funding, even for the most hare-brained or, to not be judgmental, speculative investment is not all that difficult. There are 462 venture capital firms in the US alone. There are also 2,797 private equity firms and approximately 8,000 hedge funds. All trying to produce superior returns for their investors while employing people who use the same software and hardware, attended the same half dozen elite graduate schools or business or law and share a number of other demo and psychographic characteristics.

The problem is not intelligence or access to capital. Capital is actually desperately searching for bankable ideas producing 'excess rents' as the economists call above average profits. But what the world currently could use is more income for all those consumers whose needs and desires drive most modern economies. Without them, all that capital is going to be generating sub-par returns for a very, very long time. JL

Kevin Drum reports in Mother Jones:

If increased access to capital isn't matched by an increase in labor income, then there's a mismatch: lots of capital sloshing around, but not a lot of good opportunities to invest in real world production of goods and services. The result is a financial bubble.
Advanced economies need lots of capital to operate efficiently. But is more capital always better? Longtime readers know that I have my doubts: there are diminishing returns to everything, and there's a point at which access to capital is so widespread that making access easier doesn't do much good. In fact, it might even make things worse.
Brad DeLong reviews the bidding and concludes that this is probably right:

Bruce Bartlett points to Greenwood and Scharfstein, to Cechetti and Kharoubi's suggestion that financial deepening is only useful in early stages of economic development, to Orhangazi's evidence on a negative correlation between financial deepening and real investment, and to Lord Adair Turner's doubts that the flowering of sophisticated finance over the past generation has aided either growth or stability.
Four years ago....[it] seemed to me then that in a world short of risk-bearing capacity with an outsized equity premium virtually anything that induced people to commit their money to long-term risky investments by creating either the reality or the illusion that finance could, in John Maynard Keynes's words, "defeat the dark forces of time and ignorance which envelop our future".
....But the events and economic research of the past years have demonstrated three things. First, modern finance is simply too powerful in its lobbying before legislatures and regulators ....Second, the growth-financial deepening correlations on which I relied do indeed vanish when countries move beyond simple possession of a banking system, EFT, and a bond market....Third, the social returns to the U.S.'s and the North Atlantic's investment in finance as the industry of the future over the past generation has, largely, crapped out.

We still haven't come to grips with this. Dodd-Frank was a weak bill, and it's getting weaker by the day as finance lobbies scramble to gut its implementing regulations. Likewise, Basel III's capital requirements for banks are—probably—an improvement over Basel II, but they're still nowhere near adequate. At the same time, the bargaining power of labor, already weakened by deunionization, globalization, and skill biasing, is starting to be weakened even more by the slow but inexorable march of automation.
Until we deal seriously with this stuff, we're just setting ourselves up for more misery. It's practically an iron law of finance that when capital piles up because there are too few productive projects to invest in, eventually it gets stupid. The result is a frenzy of some kind or another, and then a bust. Eventually, even Wall Street and the Republican Party will have to face up to this.