Capital Goods

The Issue

I've been struggling with understanding the concept of capital and capital goods for a little time now. However, reading Robert Murphy's article on Capital theory helped clarify the concept a lot.

I strongly urge you to read the article. Robert has given an excellent example illustrating the difference between sustainable consumption and a consumption based on capital goods, which in the short term may increase the level of consumption, but is bound to create trouble in the long term.

What is Capital?

My understanding of capital now is as follows.

Any thing requires labour and raw materials to produce. At an individual level, an individual can either expend his labour or a tradable material (usually money), to either make a product or get it from someone. When an individual works and gets money for his labour he can either save it or spend it. The money that he saves, essentially serves as a store of his past labour. Now in the future he does not have to again work for obtaining something, he can use the money saved in the past. Or, he can use this accumulated money to buy goods which "augment labour" in producing goods.  These are essentially the capital goods, which are bought with accumulated capital. 

Now there can be various means of storing his "past labour". He can do so in the form of cash, gold, any other tradable commodity, ownership in a company (stocks), livestock (farmers do this). Each form has its own particular pecularities. But each is representative of some concrete product/labour that was created in the past. Thus, the individual has literally, created his capital. I believe, the same phenomenon acting on a bigger level is what creates capital for the economy as well.

How is it destroyed?

Now, fast forward 5 years down the time lane. 

Our particular hard working individual has been working hard for the last 5 years. Spending little money other than his basic needs and some luxuries, and has accumulated a lot of capital in form of cash, stocks and outright ownership of some capital products on say, his farm. Now in this day and time he can stop working and living off his accumulated capital. If he increases his spending and starts spending more money than his capital is generating each month, he'll quickly start eating into the value of his capital goods. He'll live much better than he ever did in the past 5 years, but it is obvious that he'll not succeed in sustaining his uber-spending lifestyle for a long time, and will be quickly back to the same spot he was when he had started building his capital.

Conclusion

Not all consumption is the same. If an individual or an economy starts consuming more than its capital resources and labour are producing, then it is eating into the accumulated wealth, which was accumulated over time and with lot of labour. This sounds so simple. After all don't we all know to "live within our means" ? Yet, this was missed by all the leading economists and intellectuals of US of A? 

End Notes

I still don't understand very clearly how injection of liquidity in an economy where people have eaten into their capital assets would work. The Austrians are dead against this on grounds that it distorts the signals that entrepreneurs and companies get from the cost of capital, and thus leads to misallocation of resources. But even non-State players sell capital to the entrepreneurs and corporates. And foreign investors also inject capital into an economy. So what is so bad about the State playing the role of someone with capital coming into the market? 

I can only think of one flaw in this - The State does not have the best of track records as a capital allocator.

So what? Here the optimal return on capital is not the issue. The country would surely be happy on a sub-optimal return on its printed money, as long as it gets money into the pockets of millions of jobless people.

Is it a case of 'many a slip between the cup and the lip'?

When businesses talk socialism

From an article on the NYTimes.com about the automakers increasing the amount they're requesting by $14 Billion:

"But if the federal government balks at the automakers’ requests, that would mean the two companies probably would have no choice but to file for bankruptcy protection, because they are losing hundreds of millions of dollars each month.

And the car companies said on Tuesday that the cost of a bankruptcy reorganization, with the government providing financing to help it through that process, would be far greater than their latest loan requests. Without such help, the companies would have to liquidate, creating staggering new job losses."

It makes my ears stand up when business managers start making arguments against/for a decision citing social reasons. The automakers here are making appeals in favour of govt help citing "greater costs" in a bankruptcy proceeding, where the "cost" refers to jobs lost! Since when have businesses evaluated decisions based on jobs lost/created? The argument these buggers should have been making should have been about which operation will make them profitable faster and the little I know of the US Auto unions and their huge benefits, job cuts seem to be just the antidote that is required.

Instead, the automakers are trying to put pressure on the govt, through the general public which hears these "arguments".  The only reason I can think of is that in the immediate future, it is easier for the executives to deal with the govt than it would be to go through the bankruptcy proceedings. With Uncle Sam playing Father Christmas, what else is to be expected but everyone asking for alms without which they would collapse.

The mess called "U.S Housing Bailout"

From IHT.com:

"NEW YORK: The long-awaited U.S. housing bailout was finally unveiled Wednesday.

At a speech in Phoenix, Arizona, a signature real estate boomtown gone bust, President Barack Obama explained his plan to reduce foreclosures.

The key to understanding the plan is to remember that there are two very different groups of homeowners who are at risk of foreclosure.

The first group is made up of people who cannot afford their mortgages and have fallen behind on their monthly payments. Many took out loans they were never going to be able to afford, while others have since lost their jobs. About three million U.S. households - and rising - fall into this category. Without help, they will lose their homes.

The second group is far larger. It is made up of the 14 million households that can afford their monthly payments but whose homes are worth less than the value of their mortgages. In real estate parlance, they are underwater. If they want to stay in their homes, they will have no trouble doing so. But some may choose to walk away voluntarily, rather than continuing to make payments on an investment that may never pay off."

They govt is currently looking at favouring the first group, the article goes on to say. Irrespective of which group the govt favours, what is getting lost in the arguments is the group which is losing out when govt passes this helping hand around - the group of people who made sensible economic decisions. This stimulus is now going to create a situation, where you stand to benefit if you'd made a really really bad decision about buying your house! It would make good economic sense for more of the second group people to try and get themselves seen as belonging to the first group, or to just start walking away from the loans. The more worse off you can show yourself to be, the greater your chance of qualifying for a helping hand. It is actually a motivation for people, even those that are doing okay for themselves, to not work as hard on their jobs, and instead work on getting themselves qualified for the bounty being handed out - a much easier route than working their way out of this mess.

I absolutely dislike the proposal for the habits it is promoting - politicians helping people with their consumer debt. This will give rise to the scenario where hard working, frugal people, see their spendthrift neighbours having lived lavishly in credit for the past few years, and now when their way of living backfires, Uncle Sam comes and gives them a helping hand, while the hardworkers continue to toil without respite. On the contrary, it is the hardworking Mr.Frugal, who is paying with his taxes for the house loan of his neighbour Mr. Spendthrift. This is injustice.

Commodities Vs Tech

From an article by Jim Rogers:

http://www.lewrockwell.com/orig6/rogers2.html

"But What About Technology?"

Whenever I mention commodities in public, someone always points out that we now live in a high-tech world where natural resources will never be as valuable as they were when we had a smokestack economy. But if you read your history you'll discover that technological advances are as old as history itself: The introduction of the sleek and beautiful Yankee clipper ship dazzled the world in the mid-nineteenth century, loaded with cargo, sailing down the trade winds at 20 knots and more, averaging more than 400 miles in 24 hours and able to make it from U.S. ports around Cape Horn to Hong Kong in 80 days; within a decade, the clippers had been replaced by the steamship, no faster but not dependent on wind power; and before long the next big thing in transport had taken over, the railroad, which, of course, was the original Internet – and prices in commodities still went up.

In the twentieth century came electricity, the telephone, and radio (three more Internets) and then television (a fourth Internet). There was also the automobile, the airplane, the semiconductor – and in the midst of all of these truly revolutionary technological breakthroughs came periodic, multiyear commodity bull markets.

Even a revolutionary technological breakthrough in a particular commodity-related industry will not necessarily lower prices. For decades, drilling below 5,000 feet or offshore was virtually impossible. Then in the 1960s the Hughes diamond drill bit was invented and an explosion of technological advances in oil drilling and exploration followed. Drilling efficiency – and oil deposits – were available that had been unthinkable before this technological breakthrough. Soon there were wells 25,000 feet deep and offshore oilrigs multiplied around the world. Yet oil prices went up more than 1,000 percent in the 15-year period between 1965 and 1980.

When the supply and demand in raw materials is seriously out of whack, the emergence of new technology will not necessarily restore the balance quickly. To be sure, changes in technology, for example, have made the economy less dependent on oil. But we still use plenty of it, and whenever there isn't enough prices will rise. Computers or robots may do amazing things, but they cannot find oil or copper where there is none or make sugar, cotton, coffee, or livestock grow faster than nature allows. We can put in orders all day long on our computers for lead, but all that Internet technology will be in vain if there are no new lead mines. Technology can neither feed us nor keep us warm, and the demand for commodities will never disappear.

"But Isn't It Only Speculation and the Lower Dollar That Are Inflating Prices?"

Certainly, speculators who jump in and out of commodities can push up prices. And the dollar has been a pale remnant of itself – down against the euro almost 40 percent from the beginning of 2002 until the start of 2004 and at a three-year low against the Japanese yen. Since commodities are traded in dollars, a weak dollar will make prices appear higher. Crude oil rose 64 percent in dollars over that two-year period, but only 16 percent in euros.

But the dollar strengthened in the spring of 2004, and a funny thing happened: Commodity prices kept going up. The global recovery, particularly in Asia, was for real. We are now watching a fundamental structural shift in commodities markets, and it is called "supply" – and "China," a nation that will be consuming extraordinary supplies of all kinds of commodities for years to come. I will explain why in more detail in a later chapter. For now, however, here's the story: dwindling supplies and increasing demand.

And the dollar has nothing to do with either. Let me also remind you of the 1970s, when inflation in the U.S. was about 10 percent a year, the dollar wasn't buying anywhere near what it used to, and the economy was in a major recession – and commodity prices kept rising. We're talking another long-term bull market in commodities, and neither speculators nor a weak dollar can make that happen. Speculators can have a short-term effect only. For example, if they drive up the price of oil artificially, oil producers with excess supplies will gleefully dump their oil on the market driving the price back down. Both the dollar and speculation can have a marginal effect, but the market itself is bigger than they are.

A quote - the title of an essay by

“Sell Euphoria, Buy Panic.”

Jim Rogers - The entire article

This entire article is just too good to leave out even a small part of. I'm taking the easy way out here and pasting the hyperlink:

http://www.moneymorning.com/2008/08/19/jim-rogers/

My thoughts on his comments:

1. Economics is one thing that will surely and steadily lead the person not following its laws to destruction.  His example of U.K going bankrupt is shocking and startling!!! I must also now explore the contribution of U.K's growing bankruptcy on its India operations and how much of a factor it was in our gaining independence.

2.  "(Q): What if Thatcher had never come to power?Rogers: Who knows, because the U.K. was in such disastrous straits when she came in.  And that’s why she came to power…because it was such a disaster. "

Truth is an extremely potent and lethal weapon. In the long run, the person with the RIGHT fundamentals will gain power. But in the short run, people like Thatcher, like Hayek, like Rogers, like Buffett, will get a raw deal, be the laughing stock, till the disasterous policies of crooked/incompetent men brings about the disaster that these men could foresee. 

But the most interesting thing about this whole crisis is that men who've taken the pains to see correctly and without bias need a disaster for others to see their value. In the short run the only course available to them to is to stick to their guns, no matter what the cost.

Jim Rogers - His views on Ben's handling of the crisis

(Q): Many experts don’t agree with – at the very least don’t understand – the Fed’s current strategies. How can our leaders think they’re making the right choices? What do you think?

Rogers: Bernanke is a very-narrow-gauged guy.  He’s spent his whole intellectual career studying the printing of money and we have now given him the keys to the printing presses. All he knows how to do is run them.

Bernanke was [on the record as saying] that there is no problem with housing in America.  There’s no problem in housing finance.  I mean this was like in 2006 or 2005.

(Q): Right.

Rogers:  He is the Federal Reserve and the Federal Reserve more than anybody is supposed to be regulating these [financial institutions], so they should have the inside scoop, if nothing else. 

 (Q): That’s problematic. 

Rogers:  It’s mind-boggling.  Here’s a man who doesn’t understand the market, who doesn’t understand economics – basic economics.  His intellectual career’s been spent on the narrow-gauge study of printing money. That’s all he knows. 

Yes, he’s got a PhD, which says economics on it, but economics can be one of 200 different narrow fields.  And his is printing money, which he’s good at, we know.  We’ve learned that he’s ready, willing and able to step in and bail out everybody. 

There’s this worry [whenever you have a major financial institution that looks ready to fail] that, “Oh my God, we’re going to go down, and if we go down, the whole system goes down.”

This is nothing new.  Whole systems have been taken down before.  We’ve had it happen plenty of times.

(Q): History is littered with failed financial institutions.

Rogers: I know.  It’s not as though this is the first time it’s ever happened.  But since [Chairman Bernanke’s] whole career is about printing money and studying the Depression, he says: “Okay, got to print some more money.  Got to save the day.”  And, of course, that’s when he gets himself in deeper, because the first time you print it, you prop up Institution X, [but] then you got to worry about institution Y and Z.

I'm really impressed with his insight on the fear that's set in about the biggest men in the American Society being scared about how a single institution will lead to the downfall of their entire society. What an extremely narrow understanding of things! To me it seems more like the Fed guy is being a "yes-man" to his political bosses and lacking (a) either, the intelligence to understand the problem , (b) Or, The spine to stand up for the right thing to do. If the leaders of such a big society are going to be scared of one institution bringing down their society then their idea of the strength of their society is extremely poor, and the men themselves come across as extremely weak-kneed. 

Lessons from the Crisis - People behaviour cycles

Excerpt from a Jim Roger interview:

(Q): Earlier this year, when we talked in Singapore, you made the observation that the average American still doesn’t know anything’s wrong – that anything’s happening. Is that still the case?

Rogers:Yes.

(Q): What would you tell the “Average Joe” in no-nonsense terms?

Rogers:  I would say that for the last 200 years, America’s elected politicians and scoundrels have built up $5 trillion in debt.  In the last few weekends, some un-elected officials added another $5 trillion to America’s national debt.

Suddenly we’re on the hook for another $5 trillion. There have been attempts to explain this to the public, about what’s happening with the debt, and with the fact that America’s situation is deteriorating in the world. 

I don’t know why it doesn’t sink in.  People have other things on their minds, or don’t want to be bothered.  Too complicated, or whatever. 

I’m sure when the [British Empire] declined there were many people who rang the bell and said: “Guys, we’re making too many mistakes here in the U.K.”  And nobody listened until it was too late. 

When Spain was in decline, when Rome was in decline, I’m sure there were people who noticed that things were going wrong.

It seems like such cycles in civilisations are an inevitable result of human nature. When there are people who have to struggle, they build up their character, strength of convictions and ability to fight. And most importantly live a strenous life. They become role models for their children, and build up a society/organisation based on good principles, as they themselves are hard working. However their progenies get things ready and built for themselves. It is easy for humans to take for granted the good things, and not see the umpteen labour that goes behind keeping everything running. Love for labour and hardships is lost, self-centred individualism increases, and there comes in a desire to gain for themselves as much of the resources around for themselves, as possible. Community loyalties and fellowship is lost. And this affects organisations and civilisations the most.

And then come the 3rd generations who have never seen the human effort that went behind creating the agencies(society/org.) whose benefits they reap, it becomes even easier to take for granted, and even more difficult to recognise bad, destructive behaviour creeping in. Plus none of them is attached enough to really care much, since they've got used to living a life where they could take the organisation for granted and live a very self centred life. Then slowly this attitude starts destroying all those aspects of human life which require a high level of working together - civil structures, big businesses and moral fibre of the society.