Investment is usually a good thing, but it can be overdone.  How?  Let me list some of the examples:

  • China has overinvested in export industries, infrastructure, and housing, among other things at present.
  • The US and most of the developed world overinvested in housing, or at least, borrowed too much against it.  The same applies to the banking, investment banking and shadow banking industries.
  • The US invested too much in internet companies in the late 1990s.
  • The US invested too much in commercial real estate in the late 1980s
  • Japan overexpanded its heavy industries and real estate in the late 1980s.
  • Some invested too much in gold in the late 1970s.
  • Most developing nations invested too much money in national industrial champions for the purpose of import substitution in the 1960s-80s.
  • Banks lent too much to developing countries in the 1970s
  • The US put far too much money into growth stocks in the 1960s.
  • The Soviet Union continually overinvested from the 1960s until the 1980s.
  • People in the US put too much money into speculative investments in the 1920s.

If I really wanted to I could expand this list a great deal.  Almost every boom involves overinvestment, and often too much debt finance.  The above  are mostly macro examples of overinvestment, but it happens on the micro level as well.

  • People who are determined to get rich at all costs and lose in the process
  • People who are determined to get rich at all costs and win in the process, but lose many of the good basic things of life — family, friends, and deny themselves the enjoyment of their wealth.
  • Growth companies that invest in low ROE ventures rather than return cash to shareholders.
  • Growth companies misestimate more, and take chances that are not economic.
  • Companies that try to grow faster than their markets without a sustainable competitive advantage usually fail miserably.

It happens with governments as well, where they recharacterize spending as investment.  One particular example would be education, where little improvement comes from additional dollars spent.  Far better to move the curriculum back 60 years, and have students learn the basics.  More money is not needed; a better parenting culture is needed, plus a scope & sequence that is realistic in its pedagogy.

Fast growth is often bad growth if the return on equity for new investment is falling.    That means that the carrying capacity of the current strategy is being exhausted.  It is even worse for central planners, who don’t have good data and keep throwing money at projects with little idea of the true effectiveness.

In vestment is a good thing when it serves an area of scarcity.  It is a bad thing when it serves an area of glut.  That’s the simple summary.  I may expand on this in a future article.

By David Merkel, CFA of alephblog