The Problem of Too Much Money
yes, it’s a real thing. yes, i wish i had that problem too.
Some things in macroeconomics are not what they sound like.
For example, when people hear that America is a few trillion dollars in debt, they assume that this is a terrible thing and that the American government and that its citizens must be very worried about this large hole in their wallet. I mean, if they had that much debt, they’d be pretty worried too. It seems like the kind of thing people should be more worried about. Why do they let it keep growing? Don’t they have to worry about paying it back?
But America isn’t a person, it’s the largest empire in the modern world, and people love giving it money. Why? I’ll get to that in a bit.
People might also have heard of the trade deficit (also called a negative balance of payments), which is what happens when a country imports more goods than it exports. Intuitively, this feels kinda bad as well. If you’re buying more than you’re selling, you’re bleeding money. Surely you’ll run out someday. Back in the day, this used to concern economists so much they came up with the entire theory of mercantilism to try and get countries to stop doing this, and to build up a stockpile of money by selling more stuff to other countries.
But they were wrong too. When America imports things, it does so because importing is cheaper than making them at home. And also because they want those things. Luckily enough, there are plenty of other countries who are ready to make stuff for them. So America keeps buying because they’re getting a great deal: exchanging pieces of paper for useful things, at the cheaper prices that specialisation and trade unlock.
And the countries that are exporting more than they import? They’re doing about as well as an Employee of the Month, the guy who performs far above his pay grade, and takes home a small bonus each month. Sure, the bosses love him, but how much is that worth? Money is just the potential to buy things, and while it isn’t being spent, it’s about as useful as your “gifted kid” status from middle school. One way to look at a growing bank account is as a sign that you don’t know what that money should be doing, or can’t use it to get what you want.
The net importer is buying things they need and want, the net exporter is piling up IOUs, literal pieces of paper.
And there’s a lot of cash out there.
What happens to it? People give it to banks. Or to investors, who give it to banks. Or to trust funds, who give it to banks. Or to insurance companies, who give it to banks.
You see, nobody really wants to hold on to the money. They have more than they need, or they’d be using it. And having it laying around is stupid because inflation renders it a few percentage points less valuable each year, and because there’s only so many dollar-stuffed mattresses you can use, even in a 12-bedroom mansion. Even just preserving your status year-over-year gets more expensive, and just preserving status sucks. People need to feel like they’re moving upwards.
So it all goes to banks, because they promise to give it back, and give you a little more for the trouble. The banks took it, and created the most complex system of exchanges known to man: finance.
There’s a lot of useful things that they do with it. People want money to buy houses, cars, hospital rooms, employees, and the odd vacation to Malibu. This is great, because money gets exchanged for things people want instead of just laying around as paper, or bits. Middlemen are socially valuable nodes when they do their jobs well. You can read In Defence Of Finance for a longer case on why banks are good, actually.
But even banks run out useful places to give money to. There’s only so many people who can afford to buy houses, even with mortgages. And if banks keep trying to create more mortgages to sell, they’re going to be selling to people who can’t pay them back. That didn’t stop them of course, and for their trouble, we got 2008.
So now banks have the same problem: too much money, and nowhere to plant it. But that won’t do, their customers put the money in expecting to get more back, and they’ve got to keep their customers if they want to stay in business. The money has to go somewhere, and so it does.
It goes into billion-dollar gambling tables a.k.a. trading desks. It goes into companies building the future of trade-able JPEGs. It goes to people who give it to other people, who give it to other people, in the hopes of finding someone who knows what to do with it. It even gets loaned to failing governments, who are very likely to not pay it back.
This seems extraordinarily wasteful to most people watching.
Hayek thought so too. He wrote a whole book about it, called Prices and Production, the thesis of which was succinctly summarised by an extremely underrated amateur American economist: The Notorious B.I.G. When interest rates go down, people give less of their money to banks, and more of it goes to other people who promise them better returns. Often, those other people are mistaken (or lying), about their plans to create those returns and we end up with economy-wide “malinvestments”. Too much money chasing too few projects, ending in a gargoyle-caused economy-wide crash. You could blame the investors, but what else were they supposed to do?
Here’s an example to show just how inescapable this problem really is, no mater how much you care about good investments. Constellation Software is a really large company that buys other companies, specifically small-ish software companies that build industry-specific software in a low-competition vertical niche. These types of company are incredibly profitable, thanks to near-monopoly-like markets and the favourable unit economics of software. And Constellation Software has done a great job at picking good targets. They own more than 500 companies, which generate annual revenues of over $4 billion for the mother company. They’re doing great, the stock’s up 30 times since IPO.
They’ve done so well, their reward is to be worse at their job.
Thanks to the constant stream of cash from their portfolio companies, they’re sitting on a capital reserve of over a billion dollars. They hate sitting on this money as much as anyone else, so they’ve been forced to change their own rules to continue deploying capital. They don’t have much room to pour it back into their own companies; being vertically-integrated businesses means they stay within their niche, limiting their market size (and future growth) almost by definition.
But once you’ve made all the best investments, there’s really only two ways to keep going. You lower the bar for future investments, so you can buy more. This usually means you buy companies whose returns aren’t the most lucrative ones out there, compared to the rest of your portfolio. Or you buy bigger companies, spending a few hundred million at a time instead of tens of millions. The former strategy reduces the “R” part of your ROI equation and the latter raises the “I”.
From CEO Mark Leonard’s annual letter:
“One of our directors has been calling me irresponsible for years. His thesis goes like this: CSI can invest capital more effectively than the vast majority of CSI’s shareholders, hence we should stop paying dividends and invest all of the cash that we produce, even if it means lowering our hurdle rates.
I used to argue that we needed to maintain our hurdle rates because dropping them for a few marginal capital deployments would cause the returns on our entire portfolio to drop.”
You see this price of success across the economy. With the best players ending up with more spoils than they know what to do with. Berkshire Hathaway has over $100 billion in cash reserves. Apple has $202 billion. A total of a trillion dollars in cash is held between 13 similarly successful tech firms. What do they do with it? Berkshire Hathaway buys t-bills, which is a fancy word for “lends it to the US government”. And Apple buys securities. Which is a fancy word for “gives it to banks”. Always the banks.
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I kind of see why people get mad at bankers, but I’m also not sure how much of a choice they have. Someone has to manage all this money, and if it isn’t Morgan Stanley, it’d be one of their competitors. The sheer volumes of money unlock business models that are kind of mind-boggling to think about. If a banker convinces a large client to give them their money in exchange for a few basis points of interest, they also get to charge a management fee. All they need to do is set this fee at 1%, put the money into a few solid bonds, and make a few million each year from your 1% cut of the few hundred million. You’d be kinda stupid to say no to that kind of job.
This is also why they give their money to the US government too. Imagine you had a bank that could give you as much money as it wanted to, because it was the most productive entity in the world, and also happened to control the supply of money. That sounds like a pretty safe banks, all things considered. All the other banks live within this entity, for all practical purposes. As long as you believe the United States of America aren’t going anywhere soon, buying a call option on it’s future is a pretty good bet. The fact that it will outlast most other institutions definitely adds a few million points to its credit score. The future in general is going to be much, much richer anyway, if this graph is anything to go by.
But it’s only a good bet in comparison to all the others you could make. Very few companies last for more than a few decades. The vast majority barely make it through one. Other countries have recession that they never come out of, or governments that say “borrowers keepers, debtors weepers” when politely requested to pay up. Once you’ve dealt with your first local revolution, a few sure basis points over a decade-long timeline looks pretty sweet. And so the US continues to sell its bonds, trillion dollars of “debt” be damned.
If, at this point, you’ve started to think “this money thing doesn’t seem very real”, you’re pretty close to getting the point. It isn’t. Not without things.
Money is plentiful, good things are scarce.
Money is scarily real to real people. But to the economy, it’s just flowing water. The destinations and sources matter, but what it does in between is as consequential as what water does in pipes, and is about as intrinsically meaningful. We should care very much about where it ends up, but it seems like nobody really does. Surely we can do better.
If your model of rich people prominently features the words “boring”, “selfish” and “insecure”, well, you’re not that far off, simply because most people are those things. The population average doesn’t change much among the wealthier group. And it certainly doesn’t help that their wealth makes them the targets of some of the most powerful memetic traps and marketing plays ever devised. (And yet, I can’t find a good dollar-stuffed mattress company. I sense an opportunity here.)
Once they’ve run out of good investments, they could try patronage or philanthropy. But even there, the returns diminish pretty quickly. For anything that matters, the marginal unit of effort spent to get stuff done is pretty high. Sure, there’s a certain amount of low-hanging fruit, but finding it is tricky enough that EA built a whole religion out of doing just that. And they’ve started to butt up against the money problem themselves. There comes a point at which the number of grants available outstrips the number of capable applicants, and we get things like the Blog Prize. Oh well, so it goes.
And at some point, throwing money at the problem starts pushing things backwards. Here’s (yet another) naive model to show you what I mean. You live in a town with a hundred people, and are worth a few million dollars. You’re also a big fan of libraries, Porsches and fountains. Not necessarily in that order, but you do prefer libraries to Porsche’s, because you’re a cool guy like that.
You notice your town doesn’t have any really good libraries, so you look at your growing bank accounts and say “hey, I could build a couple of these”. So you ask around and find a few people willing to work on the project, then you go looking for some people to manage those people. You’ll need some architects and stonemasons and logistics people, and a bunch of other people for roles you haven’t thought of yet.
Then they start building, and it takes a while. Some people quit, you hire new ones who aren’t as good. Things move slower. One of your chief architects dies, now you need a new guy. You can’t find one within your town so you send people to look outside of it. A few more of your workers quit because they want more pay. You offer more money, now your recruiters have to deal with 2x the volume of applicants.
The work moves slowly. And then one day a government official walks up saying he’s planning on pushing out a new local law that restricts the size to 2:1 ratio of parking lot areas. Obviously he has no idea how deep your pockets are, and would never dream of making you consider bribery. It’s just a friendly heads-up.
This is the last straw. You’re tired, frustrated and a few million dollars poorer, so you go back to buying Porsches (you heard they’re bringing the Brewstergreen 911 back this year).
The point here is not “oh no, poor millionaires! It's so hard to spend all that money”, it’s that doing things is hard. Money can fix some of your problems, but it isn’t a direct substitute for labour, ideas, and giving a shit. At least, not yet; maybe it will be once we get the robot and benevolent AGI utopia.
Of course, rich people do accomplish things anyway. Because the really rich ones are ridiculously driven people in the first place, that’s how they made their money. Rockefeller wanted to build stuff, so it got built. And now we have the Rockefeller Centre, UChicago and the General Education Board. The Tatas spent hundreds of billions of dollars to build half of India’s good things, including their only orchestra. It might be harder to build things today, but at least patronage is making a comeback, money still goes towards cool people. Sometimes.
But if the world gets stale, it gets harder and harder to keep doing this. If you’ve ever tried to hire people, you know how incredibly hard it is to find the right person for the job. This is how it is with most things. The median worker is fairly unimpressive, the median restaurant is passable, the median NGO is terribly inefficient. The average thing is, by definition, kinda mid. People and projects who are worth investing in are rare. So money just continues floating around.
Imagination is rarer still. Cool ideas are risky, there’s always a change that they might fail, and take your investment with them. Bankers spend a lot of time convincing people that they’re infallible, so they get to take home a lot of money. They accomplish some amount of good with it, but eventually they hit their limit too, and then they invent things like CDOs and repo markets just to have something to do.
But that’s just how things are. If finance seems like too big a percentage of GDP, it’s because GDP itself is a bit too big. And the returns to managing parts of it grow as it grows. “Are these returns even real?” is a question for another time.
But I did find a fun dollar-stufffed mattress story.
If you’re a millionaire you can pay me to whisper this in your ear if it makes you feel any better.
Low-quality comment just want to say Wow you're a damn good writer. I know it's hard to be simultaneously deep, plain, and fun.
the biggie reference was sublime