Institutional Investor - Economist Michael Spence On the New Costly Money Era E-mail
Tuesday, 31 May 2011 14:56

By Julie Segal

For three decades comparatively low-cost capital has given new meaning to the term “free markets” and has been a boon to businesses and banks alike. But now Nobel Prize–winning economist Michael Spence warns that the era of discount money is coming to a jarring conclusion. This is not just because central banks may be nudging up interest rates to damp down inflation, he says. Spence, a professor at NYU’s Stern School of Business, and Richard Dobbs, a director of the Mc­Kinsey Global Institute, argue in a recent paper, “Farewell to Cheap Capital” (available at Insights & Publications at mckinsey.com), that shifts in global economic patterns have created the conditions for a protracted period of expensive capital. Spence discusses the shifts and what they mean with Staff Writer Julie Segal.

No more cheap capital?

We’ve lived in a world in which we’ve gotten into the habit of thinking that capital is pretty cheap, and that may not last forever. For a start, the fraction of global GDP going to investment in fixed assets looks like it’s going to reverse course. It has been declining steadily since World War II and the ensuing recovery, when global investment levels reached a very high 26 to 27 percent of global GDP. Since then advanced economies’ investment levels have tended to decline. And although emerging markets went into high-growth mode, the economies of even those that are now big, like China, were once so tiny that their high investment rates didn’t have much effect on the global investment rate. But we appear to be at exactly the moment when this trend turns around. Emerging economies are big enough that their high investment range — 25 to 35 percent of GDP — could cause investment rates globally to go to the 26 percent or so level over the next two decades.

So a change in supply and demand will drive up the price of capital. What does this imply?

For advanced economies, the first order of business must be to get their budgets in shape. If you have a fiscal challenge in front of you, it’s probably better to solve it sooner rather than later. It may come as a bit of a shock when rolling over debt actually starts to cost something. What our study says is that all this may be a little more urgent and that there is less time to get it done.

What about China, by contrast? 

It is in a different situation. China has an excess-savings problem, which it would do well to get rid of, provided it does it in a way that doesn’t muck up growth. The Chinese sort of got it right in the 12th Five-Year Plan; they realize they have to increase household income and, to the extent possible, provide enough social insurance to reduce some precautionary household savings. The Chinese understand this.

What risks do you see?

There’s a real threat of financial protectionism. We’re already seeing a bit of it. Countries that have a current-account deficit or a debt problem may create barriers or incentives to channel savings into domestic investments or even sovereign debt.

Isn’t the end of cheap capital good for investors?

It’s a good thing provided one doesn’t get caught in the transition. From the point of view of the ordinary investor, the returns should be high. It’s possible, however, that with the higher costs of capital embedded in asset prices, you might have lower price-­earnings ratios. You could get caught in that if you place very optimistic bets. But for savers who have accumulated assets, this is probably a fairly attractive world overall. The flip side is that maybe it’s a world with fewer investment opportunities of the sort fueled by growth. But I don’t think the higher cost of capital is going to slow the world down a great deal. It just means everybody has to get ready for higher capital costs, particularly governments with deficits and debt. I would worry, though, for investors about shifts in openness and accessibility to various capital markets, because those risk factors are on the horizon.

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THE NEW YORK TIMES
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THE NEW YORK TIMES
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CNBC WITH MARIA BARTIROMO "US not a giant in the future global economy" Michael Spence describes the changing fortune of the United States' economy in the 21st century.
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FOX BUSINESS/LOU DOBBS
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WABC RADIO -
John Batchelor and Michael Spence, Nobel laureate and author of "The Next Convergence" discuss globalization and the permanent changes it has on the global marketplace.

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CNBC SQUAWK BOX -
"Market Risk and the Economy" 

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PROJECT SYNDICATE -
Nobel laureate and Project Syndicate contributor, Michael Spence discusses global economic growth in a "multispeed" world and the challenges ahead for countries like the U.S. and China.

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TIME - What U.S. Recovery? Michael Spence weighs in on Myth #3.

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Conversations host Harry Kreisler welcomes Nobel Laureate Michael Spence for a discussion of his new book, "The Next Convergence.

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REUTERS - "Why do we want our economy to grow?" -  In "The Next Convergence" Michael Spence asks this simple yet evocative question.

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NEWSWEEK - The Stanford economist and author of "The Next Convergence" talks to Newsweek’s R. M. Schneiderman about American inequality, the Chinese economy, and how to score a Nobel.

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INSTITUTIONAL INVESTER - Nobel Prize–winning economist Michael Spence warns that the era of discount money is coming to a jarring conclusion.

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CNN - China's economic rise and the future of the global economy.

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CNN - Michael Spence examines how emerging economies are reshaping the international order.

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Google Authors - Nobel Prize-winning economist Michael Spence spoke to Googlers in Mountain View about his book "The Next Convergence."

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MSNBC - Dylan Ratigan Show: Getting America Back to Work - Michael Spence and panel discuss the sluggish job recovery and how the government can help change it.

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The New York Times - "French Minister to Seek Top I.M.F. Job"

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KUOW.ORG - "While the Economy May Recover, the Job Market Will Not"

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Bloomberg TV - Michael Spence on IMF Leadership, Greece's Default Risk.

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Author, Michael Spence at "Politics and Prose" discussing his new book,"The Next Convergence", as well as the rapid growth rates in China and India.

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Yahoo! Finance - "U.S. May Have to Live with Slow Employment Growth"

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Yahoo! Finance - "Why Globalization is Good for America"

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Yahoo! Finance - "Europe's Downward Spiral: Portugal Gets Bailout But Greek Default Unavaoidable"

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Carnegie Council - Public Affairs Program: Michael Spence addresses critical economic questions.

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Council on Foreign Relations's Michael Spence discusses his new book, "The Next Convergence: The Future of Economic Growth in a Multispeed World," as well as the rapid growth rates in India and China.

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