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Three Fundamental Laws of Private Capital

On r > g, Part IV
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A few years after “Capital in the Twenty-​First Century” exploded on the scene, the University of Chicago surveyed 36 well-​known economists, asking if they agreed with Piketty. The results? One yes and 35 no’s.

How could a book so celebrated upon publication diminish into obscurity in a few short years? Presumably, it had something to do with the problems with Piketty’s work that I detailed in my last few posts. But I think there is more to it than that. I think that Thomas Piketty, the entire economics profession, and just about everybody else very poorly understands the role that private capital plays in a free market economy.

If you open your search engine and type in “role of private capital in a free market economy” you will get: nothing. (That is, you will be directed to websites that discuss the differences between free market economies and other kinds of economies, such as socialist systems.) If you type in something like “private capital as the progenitor of all capital” you will get only my scribblings.

Is Your Humble Blogger really the only person in the history of the world ever to think about this stuff? Well, hardly. The problem is that nobody has thought about it for a very long time.

In my book, “Creative Capital” (available here), I briefly surveyed the simplistic approaches to wealth of the ancients and the desiccated thinking of the Middle Ages, then moved on to Voltaire (“Philosophical Letters,” 1734), Adam Smith (“The Wealth of Nations,” 1776), and Hegel (“Philosophy of Right,” 1820). And that’s when people stopped thinking about private capital, 198 years ago.

It’s not difficult to understand why so much good work was done in the eighteenth and early nineteenth centuries: that was the first time that private capital had appeared in human societies, as the early Industrial Revolution was getting warmed up. Prior to that, all capital assets had been owned by kings and their cronies, while everyone else was dirt poor.

But then, suddenly, ordinary, non-​royal human mortals began to get rich. Men like Rockefeller, Carnegie, and Vanderbilt became far wealthier than any king, and in some cases more powerful than the U.S. President. So stunning was the wealth produced at the end of the Industrial Revolution that when J. Pierpont Morgan died in 1913, leaving an estate valued in (today’s dollars) at some $800 million, Carnegie could remark, “And to think he wasn’t even rich!”

But it wasn’t just captains of industry who got rich. In every free market democracy everybody got rich, at least compared to the abject poverty that had been the lot of mankind since the species arose.

So why did people stop thinking and writing about private capital? I have no idea, really. Partly, I suppose, it became clear that wealth in a free market democracy is a two-​edged sword, rather like capitalism itself. The spread of wealth to the great mass of middle income people was quite possibly the best thing that ever happened to the species. On the other hand, there is no doubt that very great wealth begins to take on a disquieting character.

I mentioned above that people like J. P. Morgan (the man) were feared by American Presidents, at least until Teddy Roosevelt came along. There is also the undeniable fact that once someone has become wealthy by outcompeting others, they tend to lose their taste for competition, engaging in rent-​seeking and other anti-​competitive behaviors. (E.g., the vast oil, railroad and steel trusts that were created in the late nineteenth century; the unrivaled power of Internet-​based firms like Google, Amazon and so on.)

But, really, wouldn’t that make the nature and uses of private capital even more interesting as an object of study and thought? Apparently not. So since no one else wants to talk about it, we’ll talk about it here, starting with three “fundamental laws of private capital” (Piketty has nothing on me):

Fundamental Law #1: Private capital is the secret weapon used by the U.S. economy to out-​compete other economies.

Fundamental Law #2: Private capital is the progenitor of all other kinds of capital.

Fundamental Law #3: Private capital is by far the most flexible and useful form of capital available to any society.

Let’s take a look at these laws.

Private capital is the U.S. economy’s secret weapon

If we look at economies at the same stage of their evolution, we find an almost perfect correlation between the vigor of an economy and the amount of private capital it allows its citizens to keep and use. This isn’t just a matter of lower rates of income and estate taxation, although of course that’s an important metric. It also encompasses such private capital-​destroying tactics as state seizure of economic actors, state monopolies in certain (or all) industries, over-​regulation by states, and so on.

Over short periods of time many societies can produce remarkable results. Consider the Soviet Union between its founding and World War II, or China from Deng up to, but not including, Xi. (China, as I’ve argued for more than 15 years, has already passed its peak of international competitiveness.) But ultimately the dearth of private capital dooms them.

Even among economies that seem quite similar — the U.S., Japan and Western Europe, for example — private capital makes a big difference. The U.S. is by far the world’s largest economy and, therefore should grow more slowly than the much smaller economies of Western Europe and Japan. But the opposite is the case.

Europe and Japan have done quite well for themselves (except during the destruction of World War II), but not nearly as well as the U.S. The trouble is that in those societies, still groaning under the legacy of socialism, too much capital disappears into the maw of government and too little remains in the hands of productive people.

In the U.S., for example, output per capita per hour has grown since the end of the nineteenth century at 2.5% per annum, but this handsome number is reduced to 2% per capita GDP growth because capital that landed in the hands of government had zero productivity. In Western Europe and Japan, more capital ends up at the government level, dragging down the output-​per-​hour their citizens are able to produce.

Notice that I’m not suggesting that the U.S. or other governments should necessarily shrink — governments and government institutions are crucial to the health of economies. But excess capital in the hands of governments is deadly to economic growth and the marginal effectiveness of capital in the hands of governments is extremely modest. Transferring capital to governments needs to be done very carefully.

Next week we’ll examine my second and third fundamental laws, and observe some of the reasons why, at least up to an extreme level, the-​more-​private-​capital-​the-​better.

Next up: On r > g, Part V


Greg Curtis

Gregory Curtis is the founder and Chairman of Greycourt & Co., Inc., a wealth management firm. He is the author of three investment books, including his most recent, Family Capital. He can be reached at . Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.

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