Today I was in a downtown area, parked in an old rickety parking deck, walked past several old rickety buildings, and then arrived at my destination - one of the oldest buildings around there with a dilapidated interior filed with progressive urbanites.
Staring at the cracks in those buildings I thought to myself "this creates wealth". Of course, not the cracks themselves, which maybe be a liability, but the existence and the history of the building creates wealth. As I was thinking this, it occurred to me that a large reason that cities, and downtowns, are such wealth creators is not just because of the density and social and economic consequences of that density, but the history is a wealth creator. More specifically, the long history of capital investment is a wealth creator. The reason those old buildings are so economically powerful (even thought one wonders how they stay standing) is because not once in their lifetimes did someone have to rebuild them.
Not only did those buildings not have to be rebuilt, but they generated revenue as they stood there. Not only did these buildings have revenue generating potential ever since they were built, but their potential to generate revenue has increased dramatically as the value of the location increased. The value of the location increased, in no small part, due to the fact that wealth creators such as those buildings existed. The profit that comes from an amortized asset is the best kind of money flow in existence - almost tantamount to free money.
I thought to myself that "capital" is a very abstract concept, but yet one of the most definably useful abstract concepts in existence. Those buildings are capital. Developed economies are held up by capital. In fact, that's an understatement. Developed economies are held up by a continent of capital. Capital keeps the lights on and even checks out my groceries these days. We have more capital than we ever had at any previous time in history.The Power of Capital
Capital is fundamentally a means to weather bad times. Yet capital creates recessions.
Capital is the difference between hunter-gathers and early agrarian societies. Hunter-gather tribes had very little capital to speak of. Alternatively, the land is a renewable resource that is the capital that supports hunter-gathers. However, this resource never grows over time. Farms are actually a form of human-created capital. Yes, farms may harm the natural balance of the Earth, but they provide something definably useful to humans, and they have the basic characteristics of capital. Unlike hunter-gathers, farmers gained productivity as they invested more of their labor. This capital caused wars since humans in early history realized that ownership is never a guaranteed property an asset - a lesson we seem to forget in today's societies.
Capital causes recessions. And depressions. If there were no capital inputs to the economy there would only be labor. Everyone would always buy and produce the same amount since there would be no way to save excess productivity and there would be no fallback onto capital assets to to weather stormy times.Capital is lent and borrowed
To accountants the world is filled with debits and credits. A creditor gives their capital (usually in money form) to a debtor. Like forces in physics, there are two sides to every transaction. Because of the fact capital changes hands in the form of debt, capital has different faces, and costs to different people.Capital is both Expensive and Cheap
The United States treasury can make short term loans to banks for rates in the neighborhood of 0.25% annual interest. This is the pinnacle of cheap capital that the rich have access to. Short term loans to the poor, in the form of payday advances, and recently, micro-credit, is typically in the neighborhood of 70% annual interest. I have heard numbers going as far as 160%.
If I borrow $5 from a friend and agree to pay back $6 next week, then I will be paying a yield of 910,000%. Loan sharks get very high yields.
So called T-bonds, or US Treasury issued debt has yields of 0.01%. No really, I didn't make this up. The US was just downgraded from AAA+ to AA+ credit rating. It probably won't change the value of capital (or lack thereof) represented in the form of T-bonds. To be fair, the long term rates are closer to 4%. Whether or not this is less than or greater than inflation is up for debate.http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
You may have wondered if the price of capital is related to inequality in the world. More precisely, if the difference in price of different forms of capital is related to inequality. Personally, I wonder if anything could be more obvious.The World's power struggles are over capital
The United States is thought, by many, to have too little capital to its name compared to its debt. The US also used several federal programs to encourage people to invest in homes - a physically definable form of capital. They did this by ensuring debt to drive interest rates low. This made homes a more attractive form of capital.
China, like the US, has a problem. It doesn't have a good place to put its capital. The citizens of China have poured money into real estate because they don't have a good alternative. This is the fundamental nature of a housing boom, but it's really a problem of "too much" capital in the economy, you can read about it here.http://chovanec.wordpress.com/
China has transitioned to a more developed economy. Capital is the fundamental item needed to do so. But people in China don't get a good return on capital. Households find themselves with few options and put money into inferior investments, like real estate developments, because of this fact.
Capital has many many prices. There is the cost to borrow as well as the payment to lend, and these values exist for both the poor and the rich. My estimation is that the poor have a return on capital of around a money market account, which is 2-3% these days, and even that might be generous. The poor are also charged to receive the benefits of their capital, in the form of fees and difficulty of entry. The price the poor pay for
capital is more certainly 10% and greater, like in the case of credit cards. The rich get returns of 8%, and quite often more. The return on accounts with $100 million or more are almost consistently more than 10%, which is an impressive figure. A very impressive figure. The middle class gets returns close to the general market performance, which has been good in recent decades and may be greater than 5% for the lives of most baby boomers. The price the rich pay for
capital, on the other hand, is quite low. Corporate America has only been limited in the amount of capital they can borrow by how much people were willing to lend them.Capital is needed to solve global warming
One of the biggest problem, if not the biggest problem, that faces us today is he fact that we use hydrocarbon resources from the ground for energy. Extracting these resources requires capital. We already have that capital in place, although we will probably need more. However, natural gas plant and automobiles have not paid for the capital to produce the fuel to run off of.
Devices that use hydrocarbons are "pay as you go" because they are absent the capital investment needed to produce the hydrocarbons. The "peakist" movement, which evangelizes the demise of society due to reaching the limits of hydrocarbon production is predicated on a belief that the capital to produce the hydrocarbons to power cars sold today is a myth.
Those hydrocarbons are a myth because the capital that companies like Exxon hold today will be insufficient to keep producing the energy we need. Alternatively, the price of the capital we must invest to run our cars and our economy is expensive beyond anything ever yet comprehended by society.
Unlike a car or a coal plant or a natural gas plant, carbon free power plants do not require expensive fuel. What do they require?
The fundamental thing needed to stop global warming is a capital investment. This investment in into renewable energy sources, nuclear power plants, energy efficiently, and much much more. The thing that is indisputable is the fact that this is an investment. We have to invest in order to produce energy in a way that doesn't use oil or coal or natural gas.
The fuel for Carbon-free energy is capital.
Environmentalists that urge action to stop global warming are imploring the world to invest more now, and if we do so, we will have that value later.
A fully-constructed wind turbine produces value and uses very little labor.
Why are we not building nuclear power plants faster? I'll give you a hint - the answer starts with a "C".Imbalances in capital have remained unsolved and caused problems
Let me tell you a story of de-leveraging. A fictional story.
It was the fall of 2008 and the media was abuzz with the threat of financial collapse. While some companies collapsed, the majority the corporate world was threatened by the situation, but still intact. Seeing the problem, Earthlings had a meeting.
In the meeting, those who held bonds and those who held equity were represented. A process of "de-leveraging" was necessary, as such, it was determined that the companies of Earth would convert some amount of their rigid debt - bonds, into risky debt - stocks (equity). The representatives of bondholders were asked to order themselves in terms of who was most willing to trade their bonds for stocks. The amount that needed to be converted was assessed and the right number of bond holders were turned into stockholders.
As such, the economy returned to its normal state and a major recession was averted.
Now, this is a silly story, I know. Unfortunately, reality is more silly. The difference in the yields on capital is generally attributed to risk. A large part of the financial problems we have are caused by people buying assurances of the security of their capital from others. The problem is that the security is not represented by a building, or a power plant, or a ship. In fact, those are thought to be fairly insecure. The reason is largely because they produce a product that has a price that fluctuates.
I often wonder why markets seem less efficient than ever today. The price of almost any commodity bounces all over the place. Electricity will routinely trade in a price range that varies by a factor of 4, and then there are spikes than go up to a factor of 16 and more. That's not quite puzzling to me, the more puzzling thing is the fact that consumers pay a single price that changes very little from month-to-month.
Banks are not kept in business by capital. They are kept in business by discrepancies, or differentials in price. The world today is full of discrepancies.