A brand new mind-set about capital
Editor’s Note: The following article contains part of the basic argument from the author’s new book, The Representational Theory of Capital.
There is probably no concept more difficult to understand in business than that of capital. However, capital is central to economic thinking, so we need to get it right. To apply this concept, economists tend to identify capital as either “commodities” or “funds”. The notion of capital as a “commodity” views capital as a collection of heterogeneous things that increase the productivity of human labor – anything from an ax to a web browser could qualify. The concept of capital as a “fund” simply reduces everything to its precise monetary expression. Capital in this sense refers to all funds accumulated in the past that are available for future production.
In both current economic debates and the history of economic thought, scholars typically categorize capital theories as fitting into either or both of these two models. But that’s a mistake. In order to understand capital properly, one has to understand in a much more differentiated manner what capital is and what role it plays in economic life.
To understand the nature of capital, we must first look at property. Everything that exists in the world either belongs to someone or nobody. In other words, all tangible and intangible goods that exist in human societies are represented either by property claims of an individual or a unit, or are res nullius, “things without an owner”. Like all other goods, capital goods are represented by property claims. This representational character is the key to understanding capital. Some property claims are titles that are liquid enough to be “as good as money”, such as bank deposits or shares in a money market fund. Others don’t. Capital is not just capital goods, things, processes and ideas that exist in the real world. The property claims they represent are also a form of capital, even if they do not have a precise monetary expression.
We need an objective theory of capital (RTC) to overcome this false dichotomy. Capital goods are not only represented by property rights, but these titles form a continuum of those with low to high saleability. Because of certain characteristics, some capital goods are much harder to sell than others (e.g., ocean freighters versus trucks). However, even capital goods with the same characteristics can vary depending on the type of saleability ownership. For example, you can own farmland with a vacant title, but it’s difficult to abstractly assess the value of such land. In contrast, one can freely buy and sell shares in a publicly traded “Mid Cap” Real Estate Investment Trust (REIT) that owns similar farmland. The REIT shares can be traded daily at a price everyone knows, while the value of the privately held farmland can only be determined through the actual sales process. We can position the REIT stocks further in the sales spectrum: these stocks are obviously less liquid than stocks in a large cap company such as Alphabet, and much less than a bank deposit, as the price of the stocks fluctuates in a way that bank deposits do not do and are usually more difficult to liquidate at will.
When considering capital as the object of property claims (capital goods) or as the most liquid forms of its representation (funds), two important points are missing. The first of these is the concept of representation itself. The idea of representation allows us to overcome the fallacy of understanding capital either as things that exist in reality or as a social construct, but accepts that it is both. The second mistake is misunderstanding the myriad forms in which capital can be represented, such as title deeds, shares in a partnership, bonds in a company, etc.
The right understanding of capital creates the opportunity for greater economic well-being. Applying this more robust ontology, which views capital not only as “things” or “money,” but also as property represented by all kinds of claims – not just the most liquid ones – enables us to make more informed decisions about our own to make personal investments. This objective perspective will also enable us to better understand the allocation of capital in society. For example, understanding capital in these terms can help you avoid investing your savings in a financial instrument that does not constitute ownership of a piece of real wealth, such as unsecured bonds from a company with a poor business plan and no free assets. This could also help you avoid funds channeled by government-mandated investments in the loss of offerings like solar panels and windmills.
Inflation is a natural consequence of the government’s ability to claim existing wealth without creating its own wealth.
A comparative example can show how the RTC enhances our understanding of personal and public finances. First, let’s assume that a person has saved an amount from their income equivalent to, say, $ 10,000. He or she is considering two ways to invest the savings. The first involves buying shares in a new company, such as the IPO of a company that provides logistical support to small businesses. The second is to invest in US Treasury bonds.
Now let’s see what will happen to the money in both cases. If the money is invested in the new stake in the logistics business, the company will use the money to purchase software, computing skills, warehouses, trucks, and the like. If the business offering is solid, the remaining income from the service they provide is enough to maintain or even appreciate the value of the capital invested, as well as to ensure the distribution of dividends to shareholders. Of course, if business does not go well, some or all of the residual value of the investment can be destroyed and investors will suffer a loss.
Next, let’s consider what happens when the investor buys government bonds. The US government is currently running a large deficit, and in recent years only about 12 percent of the federal budget has been invested in generally defined capital formation. The federal government is now spending all tax revenue and making additional deficit spending amounting to around 20 percent of the entire budget. The hard earned money our investor saved flows through the Treasury coffers and is spent on things like civil servants ‘wages, retirees’ pensions, leasing of buildings and vehicles, office supplies, phone bills, etc. In the second case, no new production capacity has been added . If our saver wants to see the amount of his savings one more time, let alone interest on it, the government has to tax someone’s money, as no investment has been made that would generate a stream of income to repay the bonds.
Using the framework suggested with the RTC, you can understand that not all savings equals capital formation. For example, government bonds are “triple A” investments according to ratings companies, and no matter how secure they are, they don’t add a cent to society’s production capacity. The RTC provides a window for investors to understand what’s behind the ratings, and that hidden view isn’t pretty. If some of the money saved in society is not invested in things that will increase production in the future, but in things that are consumed with current government spending, economic growth will stagnate. Persistently slow economic growth or “worldly stagnation” can be explained by the destruction of capital, even if those savings have not yet been written off (or alternatively never will) if the government has been able to evade society with sufficient taxes to service them .
Jacques Rueff’s concept of “false rights” can help us understand the relationship between capital and inflation. Inflation is a natural consequence of the government’s ability to claim existing wealth without creating its own wealth. RTC provides us with the tools necessary to understand the shortcomings of some of today’s fashionable ideas about public finance, such as modern monetary theory. It also shows how post-Keynesian and Marxist-inspired proposals to use legal institutions to produce macroeconomic outcomes, be it funding the Green New Deal, the Great Reset Initiative, or other programs to reallocate resources through the political process, hide just a transfer of Wealth for politically favored corporate interests behind smoke and mirrors.
Capital goods vary depending on their characteristics. At the same time, the instruments that represent rights over real and false wealth are very different. RTC suggests that there is a relationship between “goods” and “goods claims” and that we should aim to properly understand this relationship. Unless we recognize the inadequacies of the tools we use to represent wealth today, we will not be able to make wealth more productive, and that is to our disadvantage individually and as a community.