Freeman

ARTICLE

Risk CapitalKey to Progress

OCTOBER 01, 1956 by WILLIAM H. PETERSON

Dr. Peterson, professor of economics at New York University, is also assistant to the Dean of the Graduate School of Business Administration.

Political oratory now to Election Day will probably once again carry barbed references to “bloated Wall Street,” “the moneyed interests,” “the New York bankers,” and so forth. For, according to the leftwingers, Wall Street is a den of iniquity conceived for parasites who “get rich” by cornering, “manipulation,” and speculation in general.

Nothing, of course, could be further from the truth. But the myth has been seducing the gullible ever since Marx’s Das Kapital linked capital with the “exploiting bourgeoisie” against the “exploited proletariat.” Quite the contrary to Marx’s thesis, capital (and hence Wall Street) does not at all exploit the American worker but, rather, equips him with the sinews of industrial might—railroads, steel mills, auto plants, generating stations, coal mines, oil wells. Capital does not stop at merely affording productive facilities; it goes on to provide the lifeblood of all the distributive facilities as well—department stores, banks, supermarkets, drive-in theaters, laundries, and all the other phases of the American economy which the economist frequently lumps into the classification, “the service industries.” In short, capital is man’s servant, hardly his “exploiter.” And it may be argued that it is the American worker himself who inadvertently is the “exploiter.” He exploits capital.

Let us see how. To get the picture, contrast the positions of the worker in capitalistic America and of the worker in largely capitalless Iraq. The American worker drives to his job in his own car. He functions in a five-day week and an eight-hour day. His plant is clean, with modern washroom and cafeteria facilities. While his pace may be rapid, it is not strenuous or backbreaking, for machines—that is, capital—do the work. Fork trucks and other materials handling equipment lift loads. Conveyor belts carry work to the worker for assembly. Steam and electric power turn lathes, spindles, polishers, mixers, and so on. No wonder American longevity is ever on the rise; the American worker may produce, but he does not engage in heavy physical labor. So to “work” out his muscles, the American worker becomes a sportsman—hiking, hunting, fishing, gardening.

With all this, the American worker’s standard of living is the envy of the world. Most American workers own their homes. They vacation every year. They view television. Their wives are fashionably dressed and their children well schooled. Their homes are crammed with electrical servants—refrigerators, vacuum cleaners, toasters, freezers, washing machines, and, increasingly, dishwashers, dryers, food mixers, ironers, disposal units. These attributes of high living standards constitute the pay-off of capital. This is how the American worker “exploits” capital, to the tune of, according to the Allied Machinery and Equipment Council, $12,000 per worker.

Capital Brings Good Working Conditions

In Iraq, the American worker’s counterpart walks to his job in a dreary shop, unsanitary and ill-lighted. Hours are long and the tasks heavy. Motive power is muscle power, sometimes animal power (camels or oxen), and infrequently electric or steam power. His home is a mud hovel and his wife and children are ill-clad. He is almost perpetually hungry and tired, and his life expectancy is short. Life in Iraq is truly a struggle for survival. Why? The conspicuous absence of capital. For. while the American worker is supported by thousands of dollars of invested capital, the Iraq worker is supported only by pennies of capital. The American farmer plows while he sits on his tractor. The Iraq farmer plods on foot while he scratches the soil with a stick.

Clearly, then, capital is the key to prosperity or, as Carl Snyder, economist for the New York Federal Reserve Bank, put it in his incisive book, Capitalism the Creator, capital is the “creator” of prosperity. This fact tends to nullify the misleading implications in statistics on “worker productivity,” for it is obvious that productivity stems not from man but from his tools—that is, capital. The driver of the Iraqi oxcart can move a half a ton 15 miles in a day. The driver of an American trailer-truck can move 30 tons 300 miles in a day—a multi-thousand-fold productivity differential. Capital makes the difference.

So it behooves us to guard capital and accumulate capital, to understand capital and improve capital. Capital is unconsumed production or wealth diverted, that is, invested—to further production. The act of not-consuming is saving, and savings constitute the only source of capital. Saving is carried on both by individuals and groups of individuals such as corporations.

Individual investment moves in diverse ways. The individual may save in a bank or buy an insurance policy. In these cases the banks and the insurance companies are intermediaries in the savings-investment process. The banks and the insurance companies pool the savings of the individuals and invest in business enterprise. But the individual may prefer a more direct investment on his own part. In this case he can invest in the shares of mutual funds and, if he is a small investor, thereby achieve a degree of diversification not otherwise possible. Still more direct investments are available to the investor. Through his broker he can buy corporate shares and hence build up the capital power of the nation. For this, he gets or he hopes to get a return.

This note on hope emphasizes the inevitable uncertainty of gain attached to capital. Capital, according to the Austrian economist, Boehm-Bawerk, is “the technical superiority of round-about production.” The two revealing words here are “technical” and “roundabout.” Technology is constantly seeking to improve capital—to increase horsepower, to accelerate speed, to heighten output, to improve quality, and so on. This means that capital once “frozen” into a machine is always in danger of becoming obsolete by new developments in technology which, of course, spells a loss to the investor but much greater gains for the nation. Again, the “roundabout” nature of capitalistic production means the inevitable production for future markets. The investor, really the entrepreneur, must accurately anticipate the future market for his wares. But consumers are demanding and occasionally fickle. Styles change as well as customs and habits. Capital, once committed in specific plant and equipment, is always at the mercy of this uncertainty. So, in the final analysis, all capital is risk capital. All capital must undergo risk. It is inherent, even in the case of preferred stock and mortgage bonds.

Risk Is Always With Us

Yet risk is so often overlooked, especially now during the seventh year of a bull market. History does not forget, and it is well to remember, Tuesday, October 29, 1929. Before then, too, there had been talk of everlasting boom. Risk was by the boards. That very summer of 1929 many believed the not untypical statement by John J. Raskob, Democratic national chairman:

If a man saves $15 a week and invests in good common stocks and allows the dividends and rights to accumulate, at the end of twenty years he will have at least $80,000. He will have an income from investments of around $400 a month. He will be rich. And because income can do that, I am firm in my belief that anyone not only can be rich but ought to be rich.

This statement, so bizarre in the hindsight of the thirties, was part and parcel of the climate of opinion during the boom of the late twenties. Today’s climate of opinion in Wall Street may be bordering on a similar over-optimism. There is talk of the magical power of “built-in” stabilizers. Corporate expansion plans are to run into the billions. Risk, seemingly, is evaporating.

But as Professor Frank H. Knight of the University of Chicago reminds us in his brilliant book, Risk, Uncertainty, and Profit, risk always dogs capital. Yields on common stock as well as on equipment bonds can never be blithely assumed at 5 or 3 per cent. The veterans of 1929, the holders of Czarist bonds, the investors of worthless uranium stock can testify to the contrary.

One more note on capital. It is not perpetual. It wears out. It must be replaced. Hence, the need of new risk capital exists as pressingly in America as it does in so-called “under-developed” countries such as Iraq. Savings must therefore go forward. And investment, too, must go on. The need of new risk capital is so great that no longer can equities be the luxury of the upper income groups. With today’s up to 91 per cent income tax rates the base for investments must be widened. Stocks, once luxuries, may now by virtue of the higher living standards of the American worker be “necessities.” They buy securities and are part owners of corporations.

This is not to say that the worker ought not be made thoroughly aware of the risk involved in investment. No one wants Wall Street to engage in the high-pressure salesmanship of “get-rich quick,” so prevalent in the hectic days before 1929. But the worker should also be made aware of the prosperity-creating, dividend-paying power of capital. The worker should see that capital equipment is as vital to industry as convenience equipment is to his wife. And behold! the most significant upshot of Wall Street as the financial supermarket of the U. S. A. M when the worker becomes an investor in American enterprise. The worker is transformed into a capitalist. What a joke on Marx! []

Reprinted from The Analysts Journal, May 1956.

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October 1956

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