Today's CPU's and GPU's are powerful enough to have damn near everything in the game be affected by physics; water, clothing, procedural animation (based upon physics instead of the very basic static animations that are used in 99.9% of games), hair, weapons, bodies, all objects in the world, etc. It is just very difficult to program such things so most developers do not do it.
I agree that CPUs and GPUs are powerful enough to have physics applied to most of the gaming world. But the question is, what quality of physics are we talking about?
Watch Dogs for instance uses physics simulations for a variety of things, like cloth, water, wind, weather, rain etcetera and the main character can interact with a lot of objects.. But the quality of those simulations isn't very high..
The more realistic the physics, the greater the cost in processing power. And that's where hardware acceleration can provide more realistic physics than you can get with software physics, because the computational power is much greater..
They instead use third party physics engines which are very limited in capabilities and may or may not work well or be optimized to run on whatever game engine they are using since it isn't a native function of the game engine.
These third party physics engines tend to be integrated directly into the game engines themselves. For example, Unreal Engine 4 comes with PhysX 3.3 integrated into the engine and is thus native to the engine. Red Engine 3 is similar, because CDPR integrated PhysX 3.3 directly into the engine itself as well. Unity 5 is another example of an engine with PhysX integration..
And the best physics engines like PhysX and Havok are designed to be easily integrated into game engines..
If you think this is not true simply look up the game Sui Generis; all of this is currently in that game. In order to make it function properly and be well optimized Madoc (the programmer) created the game engine from scratch to support everything being physics-driven; it's a native function of the engine itself instead of using a third party physics engine. Hence all of this is possible and will run smoothly even on relatively low-end systems.
I've heard of that game, and I've seen some gameplay. I like the concept, but the execution still looks amateurish if you ask me, especially the animations..