Thinking Outside The Box: The Role Of Capital

Getty

We see today financial events in the debt markets that defy what was considered normal or prudent and we see economists and pundits trying to provide a rational for such events. Things like debt instruments with negative yields, investment-rated instruments with yields below the inflation rate, below-investment-grade debt with yields below likely default risks, and housing mortgage rates that ignore the hard learned lessons of 2007.

What is going on here? Are these the results of errors in our monetary and fiscal policies or is something more fundamental at the core? I would argue that we are victims of our very success.

The most basic principal of capitalism is that capital is a scarce resource and therefore those who have it, left to their own devices, are the best deciders of where, when, why, what and how to invest it. Communism and Socialism question this principal and have proven over time to be poor alternatives. Yet we see in the events cited above that capitalism is drifting away from its basic principal to where it is now a struggle just to retain the value of the capital already gained.

Let me give my theory as to why. The history of mankind is filled with war, economic strife, negative climate events and public health crisis. These are the four greatest destroyers of capital (wealth). However, as Albert Einstein astutely observed, the most powerful force in the universe is compounding interest. Hence, over time wealth accretion overcame these setbacks to reach a point where its accumulated whole exceeded all normal and prudent needs (more on this shortly).

The biggest gain was from the reduction in serious wars, historically the most devastating destroyer of capital. Advances in understanding of economics and improved public health also eroded these destructive factors. Climate related disasters have been greatly mitigated regarding traditional threats like hurricanes, earthquakes and crop-related incidents. Spare me getting into the global warming debate here.

What we have today is a glut of capital that undermines the basic principal based on it being scarce. Hence, preservation of wealth has become the primary goal of a vast amount of the world’s liquid capital. So governments have found they can readily support profligate fiscal policies at low or no interest costs. They offer security although this is of declining value as low cost capital invites excess. I said there is a shortage of normal and prudent needs for capital. This is only because, while most of the world is still underdeveloped, the lack of good government and the rule of law in those countries makes them too risky for much of the world’s capital.

As for the industrialized world, their need for capital is declining as their populations decline. Their need is mainly for funding renewal of existing infrastructure and meeting unfunded mandates for pensions and health care. Industrial growth has been in technology where the capital is mainly to fund peoples’ labor versus machinery or brick and mortar. Their capital need is to fund buyouts and acquisitions that are just exercises in changes of ownership rather than investments in growth. I do not have specific solutions for these problems, but I do believe there are solutions.

We need to rethink how investment capital should be treated in this new world order and shape laws and regulations that create more productive channels and promote a redeployment of capital into those channels.

As for employing more capital in those countries where development capital is in greatest need, a redefining of international principals of governance is long overdue. In too many countries of the world brutal governments are protected in the name of sovereign state immunity. This principal has even been a source of much of the liquid capital in the world, i.e. capital siphoned-off by corrupt leaders.

It’s time the United Nations stopped being a democracy, too many of the member "governments" need reform. A start here would be greater transparency in the banking secrecy laws to reveal the thieves and also, better control of the resources and aid being given to these countries.

The world is awash with idle capital as well as places where it is badly needed. What is missing are new rules and principles that encourage capital to resume its traditional role in economic development rather than hiding in sheltered assets or unproductive pursuits.

There are too many pools of capital that depend on a reasonable rate of return. Things such as insurance and pension plans to name just two. Unless interest rates rise, the very foundations of these and other pillars of our universe are in jeopardy. Albert Einstein was not wrong.

Richard Lehmann is editor of Forbes/Lehmann Distressed Municipal Debt Report.

Check out my website.

I'm a former Forbes columnist, investment advisor and publisher of the Forbes/Lehmann Distressed Municipal Debt Report. As a lifetime investor in postage stamps, I've wr...