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The writer is a former banker and author of “A Banquet of Consequences Reloaded” and “Fortune’s Fool”
As the hip hop group Wu-Tang Clan rapped in their 1994 hit “C.R.E.A.M”: “cash rules everything around me”. That is, actual funds are needed for consumption or investment. The world’s “savings glut” is ephemeral. The amounts available are lower than assumed.
Savings are represented by assets — cash, bank deposits, debt securities, shares, real estate, collectibles — or their derivatives. The amount available for exchange into real goods and services depends on the realisable value of the asset, and the cash income from it.
Over time, interest coupons and dividend yields have decreased. The shift away from income reflects low rates, the concessional taxation of capital gains, the ability to defer tax, businesses that do not produce distributable earnings or cash flow, and low earnings on cash discouraging monetary distribution unless needed. This means much of the world’s savings — estimated at more than $500tn — are unrealised “paper” capital gains.
As income is frequently insufficient for financing spending or new projects, investors must sell or borrow against the value of the asset to generate cash.
This creates exposure to volatile market prices. Other than cash or near cash, investment values can be variable. In 2022, even secure bonds lost about 15 per cent from rate movements and migration of credit risk. Given the large run-up in property and share prices beyond those supported by fundamental cash flows over many decades, big losses of available savings in the future are not inconceivable.
Liquidation poses different issues. Given that residential real estate including building land constitutes almost half of global net worth with corporate and government holdings accounting for an additional 20 per cent, some of its value may not be realisable because the premises are needed.
Where assets are available for sale, there are the challenges of market timing and (for some assets, especially property) high transaction costs. There are also cohort effects, where large groups of holders sell simultaneously, which happens during a downturn. For tradeable financial assets, diminishing trading liquidity is another factor. As investors are discovering, private unlisted assets are inherently illiquid.
Changing capital flows also affect realisation. Ageing populations, stagnant or insecure incomes and shifting attitudes to saving and investing mean new cash inflows may decline over time. In the absence of buyers with ready cash, transactions depend upon the purchasers’ ability to sell other assets or obtain financing.
This scenario may force holders, reluctant to sell and lose price upside, to borrow against the value of an asset to generate cash flow. Where income is below loan servicing costs, this may set off a cycle of rising borrowings over time, creating significant economic and financial risks.
The lack of cash flows and reliance on unrealised capital gains means it is unclear how much money is actually available for consumption and investment. In an exaggerated wealth effect, spending becomes increasingly linked to asset value movements. The lack of income and available cash flow increases debt. This exposes owners to fluctuations in asset values, which increase over time as asset values and debt levels rise.
There is added risk as accruing income cannot offset capital value fluctuations. Contagion risk increases as all asset values and liquidity become conjoined. A tech founder whose wealth is locked in a start-up may borrow against his stock to finance his lifestyle. If the value of the shares falls, margin calls might force stock sales (if possible) or the sale of any real estate, placing pressure on both sectors. Markets are more vulnerable to herd behaviour and changes in trading conditions.
Plus, the uncertain value of saving limits policy options, with central banks needing to support asset values that act as collateral for loans to avoid financial stability risks. The lack of income affects tax revenues that require realisation events. Recent US proposals to tax share buybacks and unrealised gains are responses to this problem.
In Martin Scorsese’s Mafioso films, the boss traditionally keeps the proceeds of crimes safe for his “wise guys”. If anyone asks for their share, he kills them. No one can ever access their money. As the unwinding of the “everything bubble” illustrates, the accumulated wealth of the world may be similarly illusory, with savings rendered incapable of realisation at their paper value.
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