In a memorable 2012 discussion entrepreneur, investor and political activist Peter Thiel reproves Google’s Chairman Eric Schmidt:
“Google has 20, 30, 50 (US$) billion in cash, it has no idea how to invest this money in technology effectively (…) the intellectually honest thing to do would be to say that Google is no longer a technology company (…) you are investing in Google because you are investing against technological innovations.”
A composed Schmidt ducks Thiel’s frontal attack in a CNN Money clip, “there are many, many examples of business innovations (…) that Google is investing in”. Equally true, Alphabet’s (Google’s parent) cash hoard has now ballooned to beyond US$ 100 billion.
Are unemployed masses of cash a red flag that capital has lost its inherent purpose and, more grippingly, are they an indication that we might have left capitalism behind?
In this essay we first (1) propose the purposes of capital. Then (2) we suggest signals of a healthy social and economic system where capital lives out its purpose. Next (3) the ‘framework’ expands to the other side – i.e. capital not for purpose – with the eye keen on the situation today, especially as it concerns the young. We conclude (4) with a path to thriving capital living out its purpose in an economy characterized by ‘good’ elites.
1. On the purpose of capital
We start by suggesting three purposes for capital by answering three questions aiming to understand capital for what it is, what it does and what it is to us.
What is capital? Essentially a social construct, an abstraction, a “powerful pull mechanism” i.e., a most effective narrative. One immensely potent for it aggregates human effort. Society undertakes projects when it finances them – lack of capital discards most other initiatives. Capital coordinates humans and this we consider its first purpose. As social animals our most distinguished gift is that of collective action.
This capacity in the modern context is mostly realized by capital. While other coordinating devices exist such as ideology, club membership or shared national sentiment, capital is the lowest cost, most pervasive and granular approach. Whether iPhone production, the Champions League finale, or the restoration of Notre Dame, capital coordinates the efforts of the thousands, even the millions of individuals involved directly and indirectly in these projects. In short, capital is our mightiest narrative for collective action.
What does capital do? Capital transfers from the present to the future. A future with more possibilities than any non-capital enabled alternatives would ever offer. The second purpose of capital is the construction of superior, otherwise unattainable, prospects. Saving instead of consuming now means that capital can be deployed for investments. The trade-off between the present and the future allows us to consume more tomorrow via the wealth accumulated from the wise deployment of capital and investments. The proverbial apple picked from the garden tree, the services provided at the University of St.Gallen or the device you are reading this text on – indeed everything we are blessed with today – is traceable to past capital accumulation processes, some harking back to the depths of time. In short, capital’s purpose is to build our better future.
What is capital to us? At the individual level, capital releases personal creativity when we pursue those better futures. The richer times to come in healthcare, local manufacturing, education, mobility or entertainment will originate from doctors, workers, teachers, managers or producers at their most ingenious. As a quote attributed to Albert Einstein would have it, “Imagination is everything. It is the preview of life’s coming attractions.” The realization of imaginative visions with the innovative use of capital means also that “true uncertainty” is undertaken. With uncertainty data has no predictive power, and rational choice is preempted by the unknown. In other words, only our original thinking, unique emotions and a very own intuition can guide us in imaginatively investing capital. Creativity might be the ultimate achievement of the human condition, one so powerful that it elevates each of us from animals and from anything AI might hold in store. In short, capital’s third purpose is to realize the humanistic ideal of unleashing our creative potential.
2. On the signals of capital for purpose
Capital carries out its purposes within the scaffold of a particular social system and political economy. Some systems are specially good at nurturing capital for purpose. What are the signals that they are?
The first signal is capital that kills. Steve Jobs’s pondered about death, “the single best invention of life.” Not unlike nature with its cycles of rebirth, one must look for signs that capital destroys.
It vanquishes the old, the parasitic and the weak for the young, the benefactor, the strong. While mirroring nature’s progressions, this harsh Nietzschean property of capital is discomforting. It contradicts the ethics of major narratives like Christianity or Confucianism, and so capital and capitalism is often disliked. And yet any resistance to Schumpeterian creative destruction brought by capital living out its purpose is but the forfeiture of a better future, along the creative powers of individuals and collectives to imagine these original futures. There is no blue ocean or pardon, Shiva-like capital must destroy to create.
The second signal is productivity growth. Capital, deployed either as equity or debt, realizes those finer futures through efficiency gains. These come with funding for high-end basic research on Alzheimer’s, but also for revamped production lines at small factories. So deployed capital generates positive returns for the lenders, borrowers and for society at large. Since a richer future is only conceivable with more knowledge, knowledge and capital become equivalent, they are interchangeable. In a system of capital with purpose, knowledge expands in tandem with capital. Underneath knowledge creation are productivity gains. Over time these compound, and all of society benefits from real wage growth and raises in human development.
The third signal is genuine competition for capital by elites. Mancur Olson compellingly theorized about the logic of collective action where small groups enjoy coordination cost advantages. Economies are thus dominated by such small groups, often know as elites (Switzerland’s radical democracy is in many ways exceptional). Elite dominance cannot be circumvented and indeed that dominance is desirable, as an elite vacuum means lack of economic coordination or even chaos. Elite ascendancy determines which projects get capital and the direction of an economy. Will capital be available for Belt and Road Initiative (BRI) connectivity projects in Eurasia, for potential unicorns in Silicon Valley, or for Greek debt? Credit cards, mortgages and car loans see non-elites consuming capital, yet the future is built by the substantial capital pools invested by dominant coalitions. Open and competitive contests for these pools see well-coordinated small groups play out their chances at elite status. Capital allocation via open elite contests most accurately portends capital for purpose. That includes capital that trickles down to the middle classes and their projects along Harry Markowitz’ efficient risk/return frontier. Competitive capital allocation effectively mints winners that possess the most captivating future visions as well as the executive capacities to realize their promises. That is, they produce good elites.
3. On the signals of capital not for purpose
In the first part of this essay we ventured that capital with purpose (i) elicits collective action, (ii) builds finer futures and (iii) unleashes our creativity. In the second part we discussed the signals a system of capital for purpose emits. Now in the third part, we review signals from the economy that might betray an opposite reality – capital not for purpose.
The first signal of capital not for purpose is hoarding akin to the gold stashes of yore. Storage freezes and paralyzes capital which then ceases to be the vehicle for collective and creative action. Reserve balances with federal reserve banks stand at US$ 1,8 trillion (hitting a peak of 2,8 trillion in 2015), while before the crises these hovelled at around US$ 50 billion. Not knowing what to do with the resource, banks park capital overnight with central banks at no gain. Yes, unemployed capital is a red flag. So are the large amounts of non-financial corporate cash laying around, much of it at the most innovative firms, the world’s main creators of futures. The top five – Apple, Microsoft, Alphabet, Oracle and Cisco – hold a hoard of USD 600 billion. The unemployment of capital is not less serious than the unemployment of labor. Both are signs that we operate at below cooperation potential and innovation capacity, and point to a lesser future.
A second signal is negative or low interest rates, a sure bet on a future forfeited. Money priced at below equilibrium, the result of well-meaning loose monetary policies, is a prime slayer of better futures. The effects of artificially low interest rates in the Soviet Union (its state enterprises did not have to pay back debt de facto enjoying negative interest), or in Japan with its ZIRP (zero interest rate policy implemented from 1999 as a reaction to the bubble collapse) are self-evident (the Soviet economy collapsed, while Japan has been trapped for a quarter of a century at 1% growth). Negative interest rates are the mark of a topsy-turvy matrix where one takes from the future to subsidize the present. Low interest rates see less productivity gains because capital has lower pressure to work, take risks and deliver decent returns. Top disruptive projects in Silicon Valley and Berlin will still receive VC funding, yet a majority of the funds not stashed are allocated to low quality projects that can afford to pay back cheap debt (but would not have a chance if interest rates stood at 3%). Middle class projects so important to collectively build prosperous futures, with their reasonable but higher risks, are starved for capital. The economy is high and low end, hollowed out in the middle. Exiled from society is Nassim Taleb’s antifragility. That is, the cardinal property of resilient and robust systems that emerges from being challenged by stressors, shocks and mistakes. In the context of capital, stressors are natural interest rates set without the artificial pushes of central banks. The FT lexicon explains how central banks nullify the neutral rate of interest by “separating interest rates from their market clearing level.” While unobservable, the neutral rate is assumed at between 3% and 5%. Anything less might lead to declining productivity growth and possibly to great stagnation. The future depreciates. Haphazard inequality, pessimism, cynicism, discontent and the raise of alternative political options all ensue in complex interactions. This is especially unsettling in a West whose citizens are unlikely to be as stoic as Japanese or as resilient as post-Soviet Russians.
The third signal is elites that rent-seek. A big fallacy is that elites in capitalist societies must be capitalist. Let us say that they are not when they cease to deploy capital for purpose. The capitalist system, even with capital accumulation processes, private property and free markets, decays into a crony version of itself characterized by mispriced money, high entry barriers, subsidies, import quotas, near monopoly grants, licensing and a host of other rent-seeking, wealth transfer activities. The value of these rents is a social cost as Anne Krueger showed in The Political Economy of the Rent-Seeking Society (1974). Capital can multiply in sustainable and non-sustainable ways – it is either invested in rent-seeking wealth transfer projects, or in innovative wealth creation projects. Investments must not just increase one’s slice; good elites enlarge the pie.
4. On the stressors to elites for purpose
Our conjecture is that capital for purpose stimulates collective action, ushers better futures, and enables human creativity. What is the state of capital in mid-2019?
At the close end of a hypothetical spectrum capital increases productivity and diligently engages in creative destruction, while elites innovate as they fiercely compete with each other to build finer futures. At the far end of that hypothetical spectrum capital is unemployed, artificially priced, shackled by rigged rent-seeking contests. The nation that finds itself at the far end has seen the purpose of its capital compromised. Moreover, its socio-economic system is now fragile, brittle to the point of not breaking. Rather than cycles of creative destruction paralleling nature, endless stagnation and lost generations await. Incumbent organizations and low productivity growth encumber the economy, smacking middle and lower classes especially hard.
The question is whether for most of the young the present is worth more than the future?
If our appraisal says that millennials will never be able to afford homes, that the savings of retirees will not yield returns, that governments are saddled with debt they can never hope to repay without devaluations (such as leaving the Eurozone) or inflation, that there is sluggish wage growth and persistent youth unemployment, or that elections lead to results reflecting discontent … then implicitly we have answered with “yes”. We are in denial when we ascribe these above troubles variously to globalization, to an aging society or to work automatization in the context of the Fourth Industrial Revolution. These explanations are but false flags. We claim that the listed problems are related to asset inflation, to low interest rates, to elites that take no risks. All are manifestations not of capitalism but of the opposite, a system where capital captured and disarmed has lost purpose.
The stagnation trap is less a challenge of the intellect than one of collective and political will.
The signals of capital have to be recognized for what they are, but immediately after there is the will. The question here is, how do we advance the right elites to the forefront of our economic system? This is the primary – really the only – question for presidents and parliaments. Most have failed to seriously contemplate the matter, meaning others will now ponder.
The crux resides in the elites. They are necessary, they must not be forcibly replaced, there must be no revolution. Elites, quite simply, must live with stressors – the ones of capitalism. More specifically, dominant coalitions must pay the true opportunity cost for using capital. The price of money has to be set at levels that assume a future better than the present. Moreover, the state ought not to subsidize or protect elites from Schumpeterian creative destruction. Capital access is to be obtained by competitive, market processes. Relatedly, elites must prove their mettle in free global markets with no or low entry barriers.
Elites need not be noble, they merely must enrich themselves by enlarging the cake. How should society and politics deal with dominant groups? Again, with the will to invoke stressors. The natural stressor of capitalism is competition, the essential incentive structure for new wealth creation. Redistribution policies might be tempting, the downside being that the transfer from the productive to the less productive makes everybody poorer. Regulation too might prove appealing, but it only consolidates wealth transfer models as it invariably yields more rents. President Roosevelt’s Banking Act of 1933 (Glass-Steagall Act) had only 37 pages and created competition. The heavy regulations of President Obama’s Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 has 849 pages and begot reduced competition in banking.
The primary role of politics is to identify rent seeking across all industries and then to design tailored stressors. Politicians and public discourse would benefit from research by the academy rating ‘good elites’ in terms of wealth creation and potential for rent-seeking. Industries with the ‘best’ elites constitute institutional models for the rest of the economy. Areas with the ‘least’ good elites will most benefit from competitive shocks and stressors applied for the sake of antifragility and the end of stagnation. Essentially, the aggregate ‘goodness’ levels of national elites rank countries according to their futures.
The future wealth and poverty of a nation depends on how good its elites are. Elites are best in countries where capital lives out its innate purpose.