The Four Phases of Capitalism

For Karl Marx, Capitalism was the Devil's Instrument Incarnate. But in fact neither Marx nor anyone else can do without capitalism in its purest sense. In fact Marx was more concerned with remuneration relativities – the sharing of income-from-sales as between the owners of the capital equipment and the workers who operated it.

The essence of capitalism lies in pausing in the production of goods for immediate consumption, and giving time to the production of simple tools or machinery which, once completed can resume production with much greater efficiency, yielding more and better consumable results faster than the previous manual production.

As an example, look at the early pioneering days in the United States. A family might be engaged in farming their own food, and building or improving their family home. One young son of the family is beavering away in the barn on some new “invention” – to the slight disapproval of his family who would rather he joined them improving the home before winter. When the young lad has finished and unveils his new “device” feelings are still mixed. But come next harvest when his threshing machine is put to use, doing the work in far less time and with much less manual effort than before, he's the family hero.

His threshing machine is “capital”. He forfeited work on the house which could have been of immediate benefit, working on a machine which would give longterm benefit later in terms of higher productivity.

So if that's “capital”, what was Karl Marx's problem? Not the fact of capital equipment which could and can increase productivity thus in turn producing better goods at less cost. Marx's problem lay in the relative shares of proceeds from sales as between the owners of capital equipment and the operators of it. This is still a bone of contention today. In autumn of 2008 for example, Boeing aircraft workers went on a prolonged strike. One major issue was that their pay was not keeping pace with inflation – while the top bosses were getting handsome raises. It's a familiar story!

A division of rewards as between owners of capital, managements, and staff which is perceived to be fair in terms of work and risk would solve Karl Marx's objection to capitalism while maintaining its essential structure.

The development of capitalism has taken place, so far, in four stages: private, joint stock, casino, and whiz kid.

When capitalism began, way back in the mists of history as primitive man created the stone axe, tools and machines were personally developed and owned, much like the example of the threshing machine described above.

Capitalism really took off with the invention of the Joint Stock Company. This was the second phase. The idea was to sell shares in a company so that many small savers could collectively provide investment in machinery, stocks and equipment, then be rewarded by sharing in the company's hoped-for success.

This worked well in its early stages simply because it was conducted properly and responsibly. Big companies were not that many, and investors tended to buy stocks in companies within their own national borders. One investigated the company, read its financial reports, and took shares in that company because it appeared to be sound and well-managed. The anticipation was that the company, and thus one's shares in it, would prosper, enhancing the value of its capital equipment, and paying regular dividends to its investors from the company's profits. Purchasing a company's shares was based on research, and investment was a token of longterm confidence.

But then things took a different turn as capitalism moved into its third “casino” phase. Government stocks and bank accounts were boring, paying steady but paltry dividends. People wanted something more spectacular in terms of reward for their savings.

So the stock market gained rapidly in popularity as investors large and small piled in. And on what did they base their choices of companies and shares? Research, study of annual reports, recommendations of informed brokers? No. They saw particular stocks going up so they bought. Simple, and effective – for a time. But the rise in stock price was not based on increased productivity or any real improvement in value: it was simply a self-fulfilling prophecy – the more people want a limited supply of shares, the more the price goes up. Many popular stocks became vastly over-valued, which is to say very specifically, that they were valued more highly than their prospects and dividends warranted. But then who cared or even knew about company reports and prospects? They were boring boring boring, something the smart cocktail set, the flappers, the young men breezing into the Drones' Club for billiards and champagne lunch could hardly be bothered with. This was the “gay twenties”, when those with money assumed a natural right to have it grow without any effort on their part.

Aside from inflated stock prices, an unregulated market at that time was open to fraud and scurrilous dealers who began offering shares in non-existent mining operations in remote parts of the globe. But never mind what it was, if the price was going up, buy buy buy. Of course a crash was inevitable, and it came with a vengeance. The story is well documented.

Did anybody learn any lessons? In the late 1980s Japanese stocks and property grew into one of the biggest bubbles the world has known. The Nikkei Stock Index just went up and up. You could walk along a street in Tokyo and see monitors in shop windows – each one you passed showing the Nikkei higher than the last one. Japanese Warrants, a highly geared method of investing in stocks, were regularly yielding their fortunate purchasers 150% gain per year.

Again, the crash was dramatic and well documented. Twenty years later Japan has still not recovered its economic equanimity. And the “casino” phase of capitalism is alive and well and assailing ever-greater heights of economic destruction.

The next and most recent phase was to introduce further excitement into investing, with corresponding risks and opportunities for profit or loss on a previously unimagined scale. This is the “whiz kid” phase of shorts and longs, derivatives, leveraging, credit default swaps and mortgage-backed securities. This is a world in which elderly bankers stand back in wonderment as their young fast-dealing employees perform complex monetary convolutions with the banks' money of which the directors are hardly aware and which they wouldn't understand even if they were.

To look closely at just two of these fancy devices: leveraging means you don't just invest money you have, you borrow 100 times its value, so when you clinch a successful deal your profits are 100 times greater. Of course if the deal doesn't work you're 100 times worse off.

Another more recent invention is mortgage-backed securities. Instead of your local bank giving you a mortgage and keeping the deeds of your house, the bank, or perhaps a shady mortgage salesman, fixes you up with a deal you probably can't afford. But never mind. A whole clutch of mortgages are then thrown together into one big package, which in turn is chopped up into tiny pieces and sold to investors and investment funds across the globe. The risk is spread so widely, as the then-current wisdom had itself believe, that if anything goes wrong and any mortgages should default, no one will feel any pain. In the event however, the bad mortgages were a collective virus, and when they turned sour through defaults, spread their disease around the globe, and commentators with an eye to a catchy turn of phrase coined the term “toxic” to describe infected investments.

The four phases of capitalism: private, joint stock, casino, and whiz kid. What next one wonders? Could it be possible that at least a workable proportion of available capital be devoted to employing it carefully and conservatively for the purposes it originally served quite well: facilitating trade, and investment into profitable enterprises?

In fact, the model still exists in the form of Regional Development Banking, an ancient institution responsible for Germany's phenomenal growth after WW2, and the continued strength of its Mittelstand industries, the medium sized companies spread throughout the country providing high quality specialist products and services to customers throughout the world.


The Economics of Prosperity

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