A Reply to McKinsey: The Economy will Reset Global Capital Flows

The McKinsey Global Institute’s March 2013 report, Financial Globalization: Retreat or Reset?, does a masterful job detailing and dissecting the shrinking of cross-border capital flows since the economic crisis of 2007/2008.  However, while the report suggests such a trend may lead to sluggish or stifled recovery of our interconnected global economy, and suggests interventions policy makers and financial institutions should consider to reset things to make them right, I believe McKinsey has misinterpreted the cause and effect relationship between capital flow and economic vitality and misunderstands that reduction in flow is rarely a driving force behind economic downturn or malaise—merely a reflection. Therefore, no interventions are necessary.

Capital flows eased during and after the Great Recession because crashed economies needed less capital and are recovering slowly. Economies did not stall because of insufficient capital.  In languid economies worldwide there is less consumption and less demand, therefore less production and, certainly, less need for capital to facilitate plant construction, expansion, or inventory build up. Thus, we see less call for investment dollars—less issuance of corporate bonds or stocks, less clamoring for loans, and less need, in turn, for banks to increase assets to provide funding for loans either domestically or beyond our borders.  Indeed, lack of demand and uncertainty over the future U.S. fiscal and economic picture accounts not just for the absence of capital flow toward U.S. companies or toward greater U.S. investment opportunities abroad, but also for the nearly $2 trillion U.S. corporations are known to have  sitting on their balance sheets.

In addition, banks and non-bank financial institutions here and abroad, having only lately severed the taxpayer bailout umbilical and embarrassed by the public exposure of their past orgy of reckless risk taking, rather than writing more cross-border junk loans or resuming their proprietary trading gambling games, are shedding billions in toxic assets and reacquainting themselves, however reluctantly, with sound underwriting practices.

In conclusion, a sound supply of capital is the handmaiden of a thriving economy, but not its creator.  Entrepreneurial vision, a solid work ethic, and a dog-eared guidebook of best business practices are the creators of economic vibrancy.  Not capital flow. Resumed capital flow will inexorably track economic recuperation. Even without McKinsey’s suggested capital policy interventions, the light will shine again and economies, fed by wiser and safer investment practices, will flourish until history’s cycle of amnesia and greed produces new credit-fueled bubbles and the latest near-Armageddon.