05 April 2013

I Told You So, Part 4

One of the driving themes of this endeavor is that technological change, and financialization activities in "post-industrial" economies, has led to a long-term, if not permanent, decline in the real rate of return on physical investment. Whatever the finance zealots may say, earnings are ultimately determined by productivity in the real world. (Studies show that "office productivity" suites such as MicroSoft Word/Office have a negative effect.) As humanity bumps up against physics, and population, the opportunity to earn real returns diminishes. Add in the subtractive effect (on aggregate demand) of wealth concentration, and the result is diminished interest rates.

Finding data to affirm, or deny, that thesis has been hard to come by. Until now.
The investment rate (investment as a share of GDP) of mature economies has declined significantly since the 1970s, with investment from 1980 through 2008 totaling $20 trillion less than if the investment rate had remained stable. This substantial decline in the demand for capital is an often overlooked contributor to the three-decade-long fall in real interest rates that helped feed the global credit bubble.

McKinsey isn't a bunch of long-haired left-wing softies. If anything, its reputation is among the more Darwinist in the consultancy world. As it happens, I disagree with the report's grand theme: that emerging countries will push up the demand for capital, and thus interest rates. Again, infrastructure build-out doesn't generate fiduciary returns to pay the vig; that has to come from taxes one way or another. And the only way to generate the vig is improvement in production of whatever these emerging countries have to offer.
But the coming investment boom will have relatively more investment in infrastructure and residential real estate.

For being the smartest guys in the room (or why else would you get hired to "consult"?), the authors are badly disconnected from reality.

As shown in an earlier post, IT (the future of all economies?) payback period continues to extend, which, by inversion, means that real returns decline. Moving moolah into merely fiduciary instruments, as detailed in the report (housing and infrastructure don't generate moolah as return), will only mean that Great Recessions will be generated not only in The First World, but also the Second and Third and so on.

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