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carl mortished

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Does the world have too much money and too few good uses for it? Five years after the financial crash ripped huge holes in the financial system, we are again grappling with the risk of bubbles. In Canada, Finance Minister Jim Flaherty has taken steps to cool the mortgage market, fearing the collapse of a 10-year house price boom. The Chinese continue to pump money into property, confounding government efforts to restrain real estate speculation. And in Britain, sudden sharp increases in house prices in London have provoked a political row about the wisdom of government financial incentives to kickstart the building of new homes.

From historic bubbles, such as Dutch tulips to the dot.com boom, you might conclude that the global financial system has never been very efficient at allocating capital. But it seems to be getting worse, and one reason may be that the world is drowning in a glut of money; the accumulation of financial capital is accelerating at a much faster pace than the expansion of the world's economy. The problem of living in a world flooded with excess capital is considered by Bain & Co., the management consultants, in a report "A world awash with money," highlighted by John Authers in the Financial Times. Bain reckons that over the two decades to 2010, global capital resources have tripled to $600-trillion (U.S.), a level that is 10 times the size of the global economy. The money machine is now going into even higher gear, forcing the world to cope with vast oceans of capital as Bain reckons that by 2020, global financial capital will have expanded by half again to $900-trillion while the world economy will have grown by $27-trillion.

If the consultants are correct, we can expect Amazon-like flows of money sloshing about the world, creating asset bubbles and investment droughts. Indeed, the very thing we experienced over the last decade but in Titanic form. Much of the capital expansion will come from emerging markets in Asia, notably China, which will be unable to absorb all of the financial capital it creates.

The effect of surplus capital will naturally be to depress rates of return and the instinctive response of capital owners and managers will be to chase higher yields, creating the tendency for asset bubbles. The inflationary impact of too much money will be to inflate asset values, rather than the prices of core goods and services, thinks Bain. This means that businesses and investors will have to live with lower expectations of investment return. It means thinking more long-term, investing in "far-horizon" projects in a world which empowers owners of ideas rather than owners of capital. It also means improving the flow of capital to the emerging markets which have mostly failed to attract stable flows of investment despite offering superior yields.

All of this begs the question whether capital is really super abundant, or whether it is just a helter-skelter expansion in the supply of money, caused by out-of-control central banks and politicians in cahoots with powerful financial interests. Bain's definition of capital is very broad, going beyond the wealth produced by economic production, to encompass borrowing and the fancy world of financial assets and derivatives that sit on top of the inverted pyramid that is the global financial system.

Bain's solution – that we should lower expectations of short-term return and shift financial power from the owners of capital towards innovative entrepreneurs – is a bit simplistic. Real estate bubbles are the natural consequence of a financial system that still struggles to provide equity finance to new businesses in a way that balances risk, return and cost of capital. Capital markets were invented to do just that but they cannot cope with the diversity and individuality of enterprise, preferring to deal in commodity investments which can be packaged and sold as statistical risks. This leaves the "far-horizon" entrepreneur bereft and reliant on investor angels or family money.

For the expanding population of elderly savers, who see the income from their investments dwindling day by day, equity and capital markets are no solution. A pile of bricks on a plot of land may be a dumb place to invest your money but it looks strangely comforting when compared with the knowns of negative real interest rates and the unknowns of nanotechnology or sub-Saharan African equities. It is telling that from Toronto to London and on to Shanghai, people are again betting on the keys to an empty apartment. They will carry on doing so until they are offered something better.

Carl Mortished is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights.

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