As part of the historic 2nd quarter contraction in the US gross domestic product, investment spending decreased by a massive 49% under the duress precipitated by the COVID-19 pandemic. Poor general economic conditions translated to uncertainty in the minds of investors. Meanwhile, investors received government relief aid that they did not use to invest. As a result, there is now an estimated $1.5 trillion in unused capital in private equity funds alone that could be invested as soon as negative economic conditions recede.
This massive glut of capital could create an explosion of investment and is therefore referred to as dry powder. Pandemic induced uncertainty has contributed to a buildup of dry powder in the global economy, something that economists are concerned about. As early as last year, investors signalled worry over a possible wall of dry powder that could become material and distort markets.
Large waves of investment alone are not alarming in the economy at large. However the distribution of dry powder carries more cause for concern. In the context of the COVID-19 pandemic, government support to the lower and middle classes and small businesses takes the form of emergency funds and help with basic needs and expenses. Support to larger institutions takes the form of idle capital. This concentration of idle capital in larger institutions means that smaller investments such as in local businesses will be passed over as they are not worth a large investor’s time. Instead, large investors will flood a limited number of markets with investments that will reduce their return. Low interest rates, government support, and poor investments are a dangerous mix. Combined with large amounts of dry powder, they could have explosive results. Both the 2008 financial crisis and the early 2000s dot com bubble can be traced to some degree to this combination.
Another reason to worry about the decrease in investment is outlined in Harvard professor Ludwig Straub’s paper “The Savings Glut of the Rich and the Rise in Household Debt.” Straub notes that increasing inequality in industrialized nations since 1980 has resulted in a savings glut among the rich. Meanwhile, the extra capital held by the wealthy has not gone to real investments. Instead, Straub writes, it has been associated with a reduction in saving by the non-rich or bottom 90% of the population. Along with non-rich dissaving, the bottom 90% has accumulated almost 40% more debt with a significant portion financed by the top 1%. There may be reason to fear that the levels of dry powder observed in the economy now could contribute to the rich holding more of the lower and middle classes’ debt.
A system in which the poor constantly make debt payments to the rich results in the growth of wealth inequality on top of existing inequalities in income and opportunity. An investment bubble caused by the ignition of dry powder would mainly impact financial institutions, but as in the dot com bubble and 2008 financial crisis, the effect would trickle down to everyone else.
In conclusion, on top of the recession created by the COVID-19 pandemic, a more traditional recession could follow as dry powder is ignited by waves of capital flowing into overinflated investments. These investments will be concentrated in the hands of the wealthy and not in local communities. Therefore, little will be produced by the waves of investment other than debt held by the rich. Without a crystal ball, it is impossible to say whether a balance sheet recession will follow the current structural recession, but massive amounts of dry powder represent an ominous sign for the recovery and future of the US economy.