There is a point at which too much capital everywhere becomes more burdensome than helpful. We reached that point six months ago, as the vaccines were coming online.
Too much capital in the housing market leads to sticker shock, mass un-affordability and a slowdown in turnover (some might even call it a stalemate between Gen Y and the Boomers who won’t sell at a reasonable price). And if it continues on long enough, it could even impede new household formation, the single most powerful force for growth in the entire economy.
Too much capital in the bond markets leads to horrific outcomes for savers for whom risk-taking is no longer feasible. In some cases, this leads to the sort of paralysis in which millions of people resign themselves to a future of declining purchasing power in real terms and the erosion of the rewards from a life spent working and earning. In other cases it produces the opposite effect – excess risk-taking and a perilous pursuit for something – anything – with a current yield above nominal-one percent or an inflation-adjusted negative number. It’s been remarked that the combination of fiscal and monetary stimulus has forced you to turn your savings account into a bond portfolio, your bond portfolio into a dividend stock portfolio, your stock market allocation is now venture capital and your venture capital is now crypto. If there is truth to this idea, it should come as no surprise that junk bond spreads above investment grade are sitting at record tights. It should also not surprise you to see that Bitcoin is now correlated to the Nasdaq 100.
Too much capital in people’s bank accounts (I know, is this really a problem?) leads to too much inertia in the labor market. It shouldn’t be possible to have seven million more unemployed people versus the pre-pandemic economy while over ten million jobs remain unfilled, but this is where we are. Why? Many people won’t work unless and until they have to. “So what’s wrong with that?” you might ask…I’ll let you know in ten years. Can’t be good for society to have children watch their parents doing Pelotons til noon on a weekday. Employers are ready to pay and fill these jobs again. Where are the workers? Small business owners are not tycoons. They’re not exploiting labor. They’re the lifeblood of America, the engine of growth and middle class prosperity. Excess capital in the system was a help to them in 2020 to keep the bills paid. Now it’s making it very difficult to run a business.
Finally, and this is also a small business thing – there is too much capital in private equity. Let’s take the example of a small chain of physical therapy storefronts, operating in one of the fastest growing segments of the economy as the American public grows increasingly obese, older and more injury prone. The small chain of physical therapy storefronts is conveniently located in strip malls over several contiguous counties and nearly 100% supported by private and government insurance. Let’s call them Ace Physical Therapy, a relic from the days were an A was necessary to to be high up on the column in the Yellow Pages.
Well, the owner of the chain, we’ll call him Rick, is in his late 50’s and has done quite a job at building his little empire, starting from one on one appointments with injured athletes and growing it into a local brand that people trust and continue to refer friends and family to. It’s a classic American Dream type of situation. And now here comes (Jewish last name, WASP last name) private equity fund. We’ll call it Friedburg Carrington. Anyway, the Friedburg boys take a look at Rick’s business and they say “Look at those cash flows. We need those cash flows for our fund!” for all the reasons we mentioned above about investors having nowhere to turn to for current income on their capital. So they make Rick an offer, Rick accepts and now Ace Physical Therapy is a wholly-owned “asset” in the Friedburg Carrington Master Fund III, Series A, Tranche 6, which was initially funded in 2018 and will run through the end of 2028. Friedburg removes as many of the costs (and frills) from Ace’s physical therapy centers as they possibly can while Rick gets busy buying that Corvette and shopping for a new wealth manager. Friedburg has a wealth management subsidiary in-house so you already know those motherf***ers are in the bake-off. Go Rick, you’re a rockstar now (they tell you).
By the time Friedburg is done, Ace is twice as profitable and operates with only 80% of the staff it used to. And it’s brought in new staffers who cost less than the old ones. And it’s replaced a lot of personal touches and small gestures that made the patients of Ace feel special. However, it has also streamlined all the appointment booking and automated all the touch points and check-ins and data gathering. The clipboards and pencils are in the dumpster out back. Now you walk into a facial recognition scan. Your medical history floats atop a data lake in the cloud, the intake specialist at the front desk can dip into that lake with a ladle anytime information is needed. You’re in the hands of a machine.
And then three years go by and Friedburg is ready to sell. A larger private equity firm has come along, and they have already acquired nine other physical therapy chains around the country from nine other mom and pop operators just like Rick. The combined physical therapy chain can get insurance for less, retail space for less, supplies and equipment for less, software for less, find employees more efficiently and share the marketing costs across a large base of locations. It’s a no-brainer and Friedburg is happy to sell – the buyer pays ten times last year’s cash flow, because with borrowing costs at zero, why not? Besides, surely there are new monetization methods and synergies available. For example, “Why does it take a therapist 40 minutes to work with a patient recovering from neck surgery? Surely that can be done in 30 minutes per session, no? And why can’t that same therapist work with two or even three patients all at the same time, if they’re all recovering from something neck injury-related. Or back or shoulder, what’s the difference? If they’re all in one big room, lying on tables next to each other, surely we can squeeze more productivity out of each member of the staff. What’s that? They don’t like it? Fine, you’re fired. Patient doesn’t like it? Well that’s the level of service your insurance company is willing to pay for, you’re welcome to find a therapist privately.”
Now multiply this times ten then times a hundred then times a thousand then times a million small businesses from coast to coast. Everything gets a little bit shittier, a little bit at a time, because the money. The money needs an alternative to cash because the cash produces no income. In the end, trillions of it ends up in the coffers of funds that are incentivized to strip everything away from the businesses they buy, and return as much of the cash flow to the inanimate pile of money. The money. Ironically, when Rick hires his wealth manager, five percent of his portfolio ends up allocated to the very private equity fund who bought the Friedburg fund and reinvested into the very business he sold two degrees ago. It’s like a money carousel with people’s livelihoods bopping up and down on the painted ponies while the suits clip their fees from each revolution, regardless of how much (or little) fun the riders are having.
Substitute physical therapy for dentists or hairdressers or law firms or financial advisory firms or accounting practices, it’s happening everywhere. It’s inevitable.
So, I went a long way in this example to illustrate the real, tangible impact that zero percent interest rate policies visit upon Main Street, even as it acts as a palliative for the pandemic, lowering mortgages and other borrowing costs, somewhat unevenly, but nevertheless…
Many of the forces I’ve described to you had already been in place long before the onset of Covid-19. But the reaction to Covid sent them all into overdrive, hastening their impact upon everyone and everything until we reached the point of optional employment, labor and parts shortages, venture and private equity funds drowning in capital and a pumped up stock and bond market that make the prospect of forward returns require a great deal of imagination.
And because nearly everyone has gotten more enriched and simultaneously less confident about their futures (check the sentiment surveys, I’m not making this up), we find ourselves in a highly ironic situation indeed. When the tapering starts, and the asset markets convulse in response, it’s not going to feel bad at all. It’s going to feel like a breath of fresh air. Prices will reflect the end of the maelstrom. Deceleration will allow us to catch our collective breath and check our heart rate as the thuds begin to subside. Paradoxically, the slowing of all the liquidity will feel like rain in the desert, for those of us who cannot fathom watching another six months of this breakneck pace. The gains will moderate, the gusher will succumb to gravity, the sound of slot machine jackpots in the Crypto Casino going off hourly will fade into the background. You will be able to think straight again. You will be able to take your time. You will be able to act rationally, rather than react covetously.
Come the stock and bond price correction, it will feel like a gift. Come the wind-down of the most extraordinary monetary policy in history, it will feel like a relief. And if that process is to begin with the Federal Reserve’s comments this week, so be it. It is long past time.