Thursday, November 19, 2009

The Meaning of Capital, Part III

We've discussed the importance of capital and its development in the previous two posts--now for a look at our contemporary understanding of capital. Recall that Hernando De Soto wrote the "essential meaning of capital has been lost to history. Capital is now confused with money..." (The Mystery of Capital page 43) De Soto theorizes that this has happened "because modern business expresses the value of capital in terms of money." I agree with this thesis, though I believe that paper money has led to or at least exacerbated this confusion.

Money was once limited by the amount of silver or gold in circulation, and represented capital in a one to one ratio. But through fractional reserve banking, deficit financing, and the central bank's ability to print paper money the true capital represented by money became diluted with money which had no value, and in fact represented debt, not capital.

This co-mingling of money representing capital and money representing debt has led to great confusion over what is capital, and the notion that wealth may be generated by adding money into circulation. But as Herbert Schlossberg has written, this is a wicked impulse, as it attempts "to create value ex nihilo and imitate the creative power of God." (Idols For Destruction page 92)

Recall again De Soto, who writes, "Third World and former communist countries are infamous for inflating their economies with money--while not being able to generate much capital." Let that sink in. We are using Third World tactics to maintain our economy. What does that mean for our future? Again, reflect upon this.

America was once a great manufacturing nation, but over the past twenty years we have moved to a service economy. We have used hedonics and other gimmicks to show GDP growth all the while, our productive capacity is diminishing. The fact that our trade deficit exceeds $30 billion per month is evidence that we are living on capital. Rather than live within our means, we are have chosen to live on credit, delaying the inevitable day of reckoning when all our debts become due.

Again, I must quote Herbert Schlossberg. I've written on this quote before, and will again, as it is imperative that we take to heart this lesson:

"Consuming capital is perhaps the clearest sign that greed has come to dominate our economic life. That is the moral meaning of such phenomena as pollution and the transformation of farming into a mining operation through the depletion of the topsoil and the draining of the underground reservoirs. A decline in wealth ought to mean that consumption diminishes, but a moral failure prevents that from happening. Instead, a way is found to continue consumption at its former levels: living on capital. Thus the capital stock is raided. Roads, bridges, and buildings deteriorate, long-term borrowing finances current consumption, and the individual base falls into obsolescence. Paul McCracken of the University of Michigan calculates that the industrial capital stock is now falling instead of rising at its historic annual rate of 2.5 percent. We have hardly begun to pay for this in unemployment and reduced output. As more capital is destroyed by policies of taxation and inflation, people will remove it from uses that make it vulnerable. Saving will seem increasingly improvident, and more capital will either be consumed or placed into such unproductive forms as precious metals and collectibles. In any case, funds will not be available to build factories, schools, and barns. As the capital stock continues to be consumed, the pauperization process feeds upon itself. People persist in maintaining their standard of living through more capital consumption and currency depreciation. The system eventually collapses." (Idols For Destruction page 281-282)

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