Glut of Capital Behind Changes in Financial Markets

Yomiuri Shimbun

2 days ago

The trends in financial markets appear to have changed significantly over the past several years. The biggest change has been that external shocks are causing smaller price drops.
Since 1987, the U.S. stock market has crashed nearly once every 10 years. The Black Monday collapse, the Asian financial crisis and the Lehman shock all fit more or less into that 10-year cycle. However, this trend seems to have subsided considerably since 2017. One theory has it that the 2007-08 shock was so great that the markets have not fully recovered even 10 years later, leaving no room for them to slump any further. In reality, there have been structural changes beyond the shock.
Needless to say, as markets have grown in size, price drops have gotten larger in terms of absolute value. But, when looking at the percentage change, price drops have shrunk in size. Moreover, after a drop, prices now tend to recover relatively quickly to previous levels, so that slumps do not go on for months.
If this was the result of the financial system improving its resilience, that would be fine. But, in my view, there seems to be another factor at work.
I think the biggest reason why price drops have shrunk is a 'glut of capital' that can be seen across the financial markets. The most significant source of the funds is increased savings. It is known that once income goes up, allowing individuals to save, growth in savings outpaces that of income. In the recent three decades or so, savings have risen sharply worldwide.
Let's take a look at the nominal value of the global gross domestic product, so that we can estimate the growth in income around the world.
The nominal GDP for the world rose nearly fivefold from $22 trillion in 1990 to $110 trillion in 2024. On the other hand, according to the United Nations, the global population only increased 60% over the same period, from 5.2 billion to 8.2 billion. When the GDP figures are divided by population, you find that GDP per capita nearly tripled, shooting from $4,200 to $13,300.
To calculate how much savings grew, you first need to exclude the tranche of the population with zero savings. Besides looking at the average, you will also want to reference the median and the mode, the latter being the value that appears most frequently in a data set. My impression is that ultra-high-income earners have seen their incomes grow significantly in many countries. It seems this has caused the average income level to rise on a global basis. In any case, the supply of capital in the form of savings has significantly increased.
This supply has not been matched by demand, resulting in a 'glut of capital.' Looking only at the supply side does not tell the real story. Why has demand for capital been waning?
Sluggish demand for capital
Capital needs can be generally divided into short-term needs of a year or less and longer-term needs. Of these two, demand for long-term funds has been particularly sluggish.
Long-term funds are primarily provided for infrastructure development, environmental conservation and the installation of large-scale production facilities over long periods of five, 10 or 20 years.
The main reason for slow demand for long-term funds is that infrastructure development in developed countries has finished for now, leading to a slowdown in orders for new projects. On the other hand, despite strong demand for new projects in developing countries, fewer and fewer projects have been eligible for financing as borrowers have grown less creditworthy.
Predictability has also been reduced by the inability to reach a consensus on environmental conservation programs and the lack of clarity on goals for environmental investment.
These issues have become pronounced over the past 10 or so years. The situation has been exacerbated by tensions between the United States and China and, more recently, U.S. President Donald Trump's tariff diplomacy.
Moreover, international trade has been contracting due largely to tariff increases, a shift to trading with neighboring countries and a surge in maritime transport costs caused by piracy, among other factors.
As a result, demand for long-term funds has shrunk and surplus funds have moved to short-term investments. Short-term funds would normally be directed to real estate and stocks, but in the United States, memories of the real estate bubble collapse in the 2000s are still causing a lot of short-term funds to be directed toward the stock market rather than real estate.
For many years, the bond and stock markets in the United States had an inverse relationship. That means that funds would move between the two markets, depending on a comparison of interest from the bond market and dividends from the stock market. The mechanism worked like this: When bond rates rose, people would buy U.S. Treasurys, which are considered risk-free, resulting in a drop in stock prices.
Moving in tandem
However, of late, people have been buying both bonds and stocks, leading both markets to move in the same direction.
The reason that capital is not scrambling between the two markets as it did before is that there are more funds going to both markets.
In many countries, a political backlash against unequal income distribution is gathering steam. But ironically, the income gap has widened even further, driven by the influx of funds.
Many companies have been buying back their own stock by using internal reserves of excess cash. Share buybacks — which reduce the number of shares in circulation on the market and boost share prices — may make it easier to procure funds. However, companies with no forward-looking ideas for investment have little need for funds in the first place, and they may end up on the path to a diminished equilibrium.
The demand for long-term funds is, in fact, enormous. For example, if you add up the money required to maintain and repair existing infrastructure in developed countries, you will come up with a considerable sum. Roads and airport runways are suitable for investment using public expenditure based on tax revenue. But for renewal of other infrastructure projects such as railways, airport terminals, water supply and sewage systems, and power plants, there is an enormous demand for funds from the private sector.
Since there are no enthusiastic proponents of such maintenance, we often tend to forget the pressing need to discuss whether we should prioritize securing funds for maintenance and repairs even if that means restricting new infrastructure investments.
Now, I would like to touch on something a little different from the usual capital flows. That is the fact that as global markets become increasingly fragmented, the supply of funds that have functioned as a kind of insurance for maintaining the entire system is shrinking.
In the past, some countries have struggled due to unsound economic management, but when a risk of sovereign bankruptcy arose, emergency funds were provided from the outside as what looked like insurance payouts.
However, countries are increasingly only willing to help those in distress who are 'like-minded.' If this is not the case, no support will be extended even if the debtor is not an 'enemy nation.'
In many cases, economic collapse is the country's own fault. That said, if one imprudently throws a rotten orange into a box of oranges, it may cause the rest of the citrus to rot as well. And a failing country may well be a neighbor to 'like-minded' countries.
Regardless of the politics of the country facing bankruptcy, if it can carry out the appropriate measures for economic restructuring, there should be a framework that can quickly provide the nation with support.
Hiroshi Watanabe
Watanabe is a visiting professor with the Faculty of Business Administration at Tokyo Seitoku University. Previously, he was vice finance minister for international affairs and a professor at Hitotsubashi University. He also served as governor and chief executive officer of the Japan Bank for International Cooperation, and president of the Tokyo-based Institute for International Monetary Affairs.The original article in Japanese appeared in the July 27 issue of The Yomiuri Shimbun.