What would bring private equity returns back?

We are probably going to have 10, 15, 20 years of lots of capital chasing returns that are not great. I don’t think that this is an acute issue that’s going to get fixed quickly, like it was in the late 1980s, when you had a similar problem solved by a massive downturn, so that four or five years later you could resume investing. Nothing of the sort has happened today.

The venture capital industry is a great example. In 2000, I would have said there’s this massive overhang of venture capitalists; a lot of them are going to go out of business, and a few years down the line, venture capital will be a good thing to invest in again. But nothing of the sort happened; they just stayed around and raised lots of money. So I think we’re dealing with an overhang that’s going to be with us for many years.

Why did the overhang persist despite the dot-com crash?

The way to see the housing slowdown is as a deflationary shock. When the bubble ends, it’s like the ATM machine in everybody’s house gets turned off.

Part of what’s driving the overhang is the baby boomers’ need to save for retirement. The savings rate in the U.S. at this point is at 0 percent. But we already have an overhang because of high levels of savings in China and Japan and growing levels in Europe. Now, the savings rate in the U.S. is going to start going up, a lot, and I don’t think it is going to come down elsewhere.

Say you want to earn 70 percent of your pre-retirement income in retirement. How much do you need to save? The answer is very sensitive to the return you can expect to make. But even if you expect returns of something like 5 percent after inflation, which is quite high historically, the U.S. would have to save about 10 percent more of its GDP than it does now. Basically $1 trillion a year would have to shift from consumption toward savings. You could argue the shift actually has to be even bigger than that, because if you have $1 trillion going into savings out of consumption, investment returns will go down. The equilibrium savings point will be incredibly high.

When do you see this shift filtering through to asset prices?

This is the question I spend a lot of time thinking about on the hedge fund side. One big new idea that we’ve had over the last few months is that one of the main sources of global liquidity driving asset prices today is the rise in oil prices and the petrodollar recycling effect.

The rise in oil is like a $1 trillion per year regressive sales tax on the middle class, which would otherwise spend that money on consumption. The money goes primarily to very wealthy people in Russia, Saudi Arabia and various other places. And they invest it. Now, normally, if you had a $1 trillion sales tax, it would be bad for stocks. But what would happen if the government took the money and used it to invest in the equity markets? Our analysis shows that the net effect is the markets actually go up. So the financial petrodollar effect so far is dominating the real effect of the higher oil prices.

What would disrupt this capital flow?

I think there is a point where higher interest rates may break the cycle. You shouldn’t underestimate central bank monetary policy. But the question really is what happens with oil. If oil prices stay where they are, I think the petro­dollar effect could go on for quite a while. One really big question is what would happen if the price of oil fell sharply. All of a sudden there would be no petrodollars supporting the financial markets.