The Illusion of Capital

Ever read one of those articles that gets you more and more excited the further into it you read?  One of those “Oh yeah, that’s what I’ve been thinking, but didn’t know how to express it!” articles?

Well, today’s Daily Reckoning was like that for me. In the article The Illusion of CapitalDan Amoss hit the nail on the head over and over.  When you read through it and get down to the part that he quotes from March 2007 – more that a year before shit hit the fan in 2008 – and see how much sense he makes, it’s pretty impressive.  I’d quote the entire article here, but that wouldn’t be proper, so I’ll comment on some excerpts.

For example, as a simple observation Dan writes: Here in America, the world that flies past the window is one in which capitalism has become a wealth-transfer process instead of a wealth-creation process.

That should be obvious to everyone, as we’ve transitioned from a manufacturing economy (prior to the 1970’s) into an information/services based economy.  The problem with this is that wealth transfer doesn’t CREATE anything – it’s a zero sum game.

Dan goes on to give an example: A few weeks ago, as I was rolling up the tracks from Baltimore to New York, my gaze landed on an oil refinery. A little while later, I spotted a casino. Then I started to think about these two very different forms of capitalism — one that relies on an intensive investment of physical capital and one that relies almost entirely on paper money.

Is one of these forms of capitalism inherently better than the other? Does one of them produce a more enduring prosperity?

Yes, to both questions.

It’s pretty obvious (to me, although I know several college professors who would disagree) that the casino doesn’t produce a damn thing; it simply transfers wealth from the gamblers to the casino company, in this case Harrah’s. It has the exact same economic effect as simply giving the money to someone, after passing it through some unneeded people (casino employees in this case) to skim part of it away.  No wealth was created – the money simply changed hands.

Compare that to what happens at the refinery.  Situated on the Delaware/Pennsylvania border, this 800-acre campus covered in miles of steel pipe has the capacity to crack 175,000 barrels of crude oil into refined products in a single day.

I’m going to make this simple.  Those refined products are the result of capital investment. Someone with capital (a representation of goods which have already been produced) took a risk and made an investment (transferred their capital to someone who could put it to productive use – they hope!) in a refinery. The refinery takes raw material (in this case crude oil – and it’s called crude for a reason) and produces actual goods (gasoline, diesel, jet fuel, asphalt, tar, naphtha, etc) that others purchase.

If others aren’t willing to spend that much, then the refinery loses money over time, which means it eventually goes bankrupt, which means the investors (Anyone remember them? They’re the fat cats who had the money to invest that made this whole thing possible.) lose their investment.  The investors took the risk, but they were not rewarded, because they didn’t make wise decisions in the deployment of their capital.  Which is as it should be in a capitalistic society.

On the other hand, if others (if you haven’t gotten it by now, “others” is a synonym for consumer) are willing to pay a rate that is greater than the actual cost of the raw material (crude oil) plus the overhead of the refinery (equipment and employees)  then the refinery has a positive return on the capital invested, and the investors reap the profits.  Again, this is as it should be.

Back to the article….

Dan says: Yet in the all-important calculation of gross domestic product (GDP), a dollar pumped into Harrah’s one-armed bandit is treated the same as a dollar Sunoco invests in maintaining its refinery. For those who only look at surface numbers, GDP can be a very misleading gauge of economic health. In itself, it tells you nothing about capital formation.

This is key. What a casino does is basically the same as what the government does – they take money from one group and give it to another.  The difference is that no one is forced to gamble in a casino. If you have money and you want to gamble, go for it, but no one is making you do it. You can just as easily put a wad of dollars into a jar or piggy bank and save it.

On the other hand, when the government wants to transfer wealth to someone – or a group of someone’s, such as AIG, BoA, GM, Solyndra, etc. – they first have to forcibly take it from others who have capital wealth.  Remember that capital is simply a monetary representation of goods which have already been produced.  Capital represents the difference between “stuff” that has been produced BUT not yet consumed.

Capital is savings. Without savings nothing new can be produced – most everyone would simply be busy running around doing sustenance farming simply to stay alive.  This was the case for most of humanity for thousands of years.

But when someone produces more than they consume, they can invest that time savings (representing their excess production) into others, or take a vacation. Their capital can be used to build machines to pump water from coal mines and make them more productive, making the price of coal cheaper, thereby raising the living  standard of everyone.

Or harness the coal energy to make steam to power textile mills – suddenly it doesn’t take everyone days or weeks to make a shirt, that time is freed up to do other things.  Like learning to read, building a better house, figuring out how to cross pollinate plants to create disease resistant strains, etc.

That’s capitalism at work.  It’s the only system that transfers wealth efficiently to from those who (for whatever reason) have accumulated more wealth to those who have ideas and need capital to put the idea into action.



%d bloggers like this: