graphic: House Speaker Nancy Pelosi via Flickr

It isn’t just quantitative easing that hurts middle class investors, these tax cuts for the rich are a big problem. We know that the wealthy aren’t going to spend their tax cuts. They haven’t so far, and there is no reason to think that will change. They will invest it, as they have been doing. There is so much capital chasing financial investments that yields are down, and Wall Street is busy creating new ways to make money with money.

The simple explanation is supply and demand. There is an ever increasing flood of money looking to buy a limited number of financial assets. That will, absent other factors, drive up prices for financial assets. The rich are there first, and as small investors try to buy in, they pay more for less. There are a number of reasons for this, discussed by Thomas Palley in this clear and sensible article. I am going to single out one. Tax cuts mean more cash chasing a relatively fixed pool of investments.

There is a finite number of investments available. There is the stock market, and bonds and commodities. Then there are hedge funds, venture capital funds and private equity funds. The securitization market, which was absorbing an enormous amount of money, has dried up, and shows no sign of returning. The real estate market is available, but largely through pools on other markets.

The stock market has a fairly static group of investments. Lately we have seen some new issues, GM and Citi for example. The demand for these securities, artificial or not, has been voracious, and the justification for the offering price and the current prices is unclear. The key point is that it is a limited pool.

Bonds are available, and prices for new issues have been great for issuers. Microsoft sold $1 billion with an interest rate of under 1%. Generally interest rates are at historic lows. There is no return there, and if interest rates go up, as they will in time, buyers will take losses in the value of their bonds unless they hold to maturity, which will also suck because the interest rate is so low.

There is too much venture capital out there, and the inflow into VC funds is dropping (.pdf). Private equity funds are sitting on a huge pile of cash, $500 billion or so, but they aren’t buying according to this and this. Of course, if mergers and acquisitions pick up, the supply of investments available to small investors will drop.

Hedge funds are growing again, but that isn’t good news for anyone except hedge fund managers. These behemoths are huge players in High Frequency Trading and other speculative activities, as they must be to justify the ludicrous fees they charge. Hedge funds are enormous noise traders, drowning out information about the real value of a security in favor of some meta-value, like what others think about a stock or what they think others think about a stock.

Now we have more noise trading than ever. . . . [cont'd.] The New York Times discusses day-trading Chinese funds. Another kind of noise is introduced by exchange traded funds, described here.

And I don’t even want to discuss commodities trading. Speculation in these markets long ago swamped the inputs of producers and sellers.

On top of all that money that is trying to find a return in financial assets and driving up prices, President Obama cuts a deal with the Republicans to increase the amount of money available to the hyper-rich and their corporations. All that money has to go somewhere, and we know it isn’t going into consumption. Prices for financial assets go up, and returns drop.

Now in the face of this morass, look at a 50 year old parents who managed to get their kids through college without too much debt and are ready to start accumulating money for retirement. They realize they are facing cuts in Social Security and Medicare, and they have to save for those. Take a look at that last link and see how much money you have to save to have a chance of growing an adequate retirement fund on top of those mandatory savings.

As you start your investment program, you know you are behind the curve. When you buy 100 shares of stock, you have no idea whether the price reflects the fundamentals of the stock. And if you are buying 100 shares, some rich family is buying 10,000, and driving the price up ahead of you, and some hedge fund is buying 100,000 shares and driving the price up further.

The rich are eating your future. And the government is helping.