Completely false. Let's talk about how investment money is used, and how that impacts valuation.
Say that a friend has started a new farm as a business and he's seeking investment. He'd like a cash investment in order to buy a tractor, harvester, and combine for the farm, which he can't afford himself. So I make the investment and the farm buys the equipment, which enables the farm to grow substantially more crops (vs tilling, planting, and harvesting by hand). By growing more crops with that equipment, the farm has vastly more revenue and earnings.
This farm has actually grown more crops than it could have otherwise - the investment led to the creation of wealth. The crops are net additional wealth, and the farm's ability to grow and sell them for revenue leads directly to the increase in the farm's valuation.
The farm grows and hires more employees; it's also an engine of job creation. All made possible by the investment, without which the farm could not have gotten started.
> Hedge funds and the like.
And what do hedge funds do with the investment money they receive from the wealthy? Do they put that cash under their mattress and somehow generate returns by doing that? No, they invest it in companies which use the cash to create wealth.
I was talking about something different.
It's true that hedge funds and mutual funds also invest in the stock market, which is a secondary market where the money doesn't go to the original issuers. However the existence of a healthy and liquid secondary market is what gives primary investors the confidence to buy stakes (or lend) to start-ups in the first instance. Who would want these assets if they literally had no choice but to hold onto them forever (or until maturity or acquisition or bankruptcy).
Becoming 'increasingly divorced' from economic reality doesn't mean that it's completely separate, only that even in times of low growth, the ultra rich have high yield funds available to them which exacerbates economic inequality. It's just a trend. Or as Piketty states, r > g. Hedge funds used to be entirely defensive against market downturns, today they're increasingly run by speculative traders, many of whom offer outsized returns.
That's really not a good example of what we're talking about here. A single family farm is not a profitable business at all. There was an HN story about it just a couple of days ago. https://news.ycombinator.com/item?id=10823747
He'd like a cash investment in order to buy a tractor, harvester, and combine for the farm, which he can't afford himself. So I make the investment and the farm buys the equipment, which enables the farm to grow substantially more crops.
No you don't. He might get a bank loan, in which case he is actually paying a fee in order to borrow that money. Now, if you were talking about the profitability of people paying you to borrow money, now you're in the right ballpark. I hear it's quite a profitable business.
Look I'm not talking about hypothetical small business hand wavy stuff, I'm talking about the trillions of dollars floating around at the top end. Most of which is currently flowing into real estate, powering various bubbles around the world.
I'll give you an example: from what I understand, Larry Ellison doesn't actually sell his stock in order to buy islands. He uses it as collateral to secure a loan. Those loans (something like 10 billion dollars worth at this point) can be spent/invested/leveraged, but it's not directly taxable because it's a loan. That's the kind of thing that you can do when you have a few billion. You don't even have to spend your own money. The net increase in the value of his real estate holdings is more than enough to pay the interest. Now, try playing that game if you have zero billions.
http://www.bloomberg.com/news/articles/2014-09-25/larry-elli...
No, they invest it in companies which use the cash to create wealth.
Apple isn't a good example either. Companies do get cash from IPO's. After that, having a valuable stock is certainly nice. Apple doesn't fund operations by selling their stock. If the stock doubles, Apple doesn't get that money. Indirectly, of course Apple does issue stock as bonuses to employees, and buys back stock to return cash to investors. If Apple was privately held they'd make just as much money. They don't need the stock at all, it's just a side benefit that they can take advantage of when they make compensation packages.
Right, but if he converts money into land, the land does get taxed. Additionally, he pays a sales tax when he purchases the land.
> That's the kind of thing that you can do when you have a few billion. You don't even have to spend your own money. The net increase in the value of his real estate holdings is more than enough to pay the interest.
False. He is spending his own money, because he still pays back the loan. He borrows money, buys some land, then pays the loan back.
Hedge funds and the like.
> leads to their valuation, which leads to the return on our hypothetical investment.
'Return' on an increase in valuation isn't a real return. It's exactly like poker.
The way markets are supposed to work is you invest in an IPO, then you get a dividend sometime in the future, and then maybe the company buys back your shares.
The way it generally works for most people is you buy shares on the open market, then someone else buys those shares from you. This has nothing to do with the 'reality' of the company because both of you are speculators, neither has given money to the company, and neither has received money from the company. You're both just playing with poker chips.
> Can you describe how these investment vehicles work such that they're earning a return while being disconnected from the real world? Where does the money come from for the returns?
You buy into the market (non-IPO). When the value goes up, you sell. You're selling to other investors.
So the answer is, much of the money for the returns comes from other investors (not unlike a Ponzi scheme, however since you're both speculating, it's more akin to a poker table).
On a large scale the way it works is that hedge funds and traders are the ones making money, at the expense of less sophisticated traders, like mutual funds, pension funds, and retail traders.
Of course, this doesn't include the fact the dividends and buybacks actually are real, and do represent a non-trivial portion of the market, but there certainly is a large enough amount of investment vehicles which are divorced from the 'real world'.