On the Role and Effect of Investment on Economies

by jovialbard

Economies exist to solve one simple problem. Sometimes an individual has a surplus of one thing and a need for another. That’s the essence of it.

The simplest solution to this problem is through direct trade. However, direct trade isn’t the best way to resolve complex issues of supply and demand. The introduction of currency allows for more complex exchange interactions.

There is a different type of surplus and need that mere exchange, whether through barter or currency, cannot help to resolve. That is when the surplus is potential. The only way to trade someone a surplus of potential is to wait until that potential is actualized. This is where investment is introduced into an economy. An investor trades a surplus of resources now for some portion of the resources that exist when the potential is actualized. This facilitates a more vibrant economy by making it easier for new ideas to flourish.

When a particular sector of the economy flourishes it tends to profit above the normal living expenses of those in that economy. Essentially there is money coming out of the rest of the economy and accumulating in the profitable part of the economy. Part of those profits undoubtedly go toward improving quality of life. Such quality of life improvements are expenses that are thus recirculated through the rest of the economy. Another portion go toward investments. Investments that increase productivity are, again, expenses that circulate through the rest of the economy. Other investments may be made toward other sectors of the economy. So the majority of the money supply that pools in a profitable sector of the economy will, one way or another, eventually recirculate to the rest of the economy.

As an aside, I won’t attempt to moralize about whether these profits and localized gains in quality of life are ‘good’ or ‘evil’. That’s not what this essay is about. This essay is about mechanics, so I’ll save any discussion of morality for another day.

However, the picture is very different when looking at the investment sector of the economy. It doesn’t quite behave the same way, or rather, it does but with different results. When investors are successful it means they are profiting from their investments. These profits mean that some portion of the available money supply is flowing into the investment sector and accumulating there. Certainly a portion of these investments improve the quality of life of those employed by the investment sector. So there’s nothing different about that, but what happens to the rest of the profits? And surely there will be additional profits, what portion of investors is satisfied just earning enough to live on? Can it be invested in productivity? Not really. The investment sector doesn’t produce anything. Rather, the means of production for an investor is money. They can hire employees, but that’s essentially just an investment in another investor, it doesn’t employ anyone or require purchasing anything outside the sector of investment. So what do they do with the profits? Just like a profitable trader in goods and services they can invest the surplus. That is, the surplus goes into the investment sector… where it already was…

So essentially… as long as the investment sector is profitable on balance money will be flowing into the investment sector of the economy, but how does it flow out? How does it recirculate? You could say the loans that the investment sector provides to other sectors of the economy allows it to recirculate, but that isn’t really true. That money still belongs to the investment sector, it’s just temporarily being utilized by other sectors of the economy, they have to give it back at some point. The portion of the money supply owned by the investment sector hasn’t decreased at all. In fact, it has likely increased in the form of interest or shared profit.

Should this trend continue, with the money supply naturally flowing into the investment sector without ever flowing out, what happens to the sectors of the economy that produce goods and provide services? How can their share of the money supply do anything but shrink? How can they do anything but become increasingly dependent on loans from the investment sector? And as they become more and more dependent on loans, as their balance books look worse and worse, wouldn’t the investment sector itself start looking like the most tempting place to invest? Over time the idea of investing in investment would become more and more appealing. That’s where the winners are. As this happens less and less available money exists in the various sectors of real goods and services. The localized inflation of the money supply in the investment sector and deflation of the money supply in the rest of the economy would only accumulate. How could the cycle possibly end?

There is one way for the accumulation to end, for the money to flow back out of the investment sector: Failed investments. When an investor gives money to some venture without getting any back, that money has left the investment sector. The person engaging in the venture has spent it, more than likely on other goods and services. That money is now flowing through the economy of goods and services. The investor has no way to reach that money except to demand it from the venture they invested in. If that venture has failed to profit then it cannot get the money back. The investor walks away with less than he started but the economy of real goods and services now has money that it didn’t have before. Does that sound like a good thing? It shouldn’t. Why? Because that’s an investor whose ability to serve their vital role in the economy has been diminished. They are less able to actualize potential. When this happens dramatically we call it a bust. The investment sector, during a bust, is essentially suffering massive deflation. The whole economy suffers an inability to actualize potential and productivity temporarily grinds to a halt. In time the investment sector stabilizes. As it does it begins to serve it’s incredibly vital purpose in actualizing potential. As it does so more and more successfully it begins to slowly consume the available money supply. Boom, bust, boom, bust. There is no guarantee when the bust will happen, because, strictly speaking, it doesn’t have to happen. If the investment sector of the economy contented itself with owning the entire money supply it could continue to bankroll the rest of the economy with loans that can never really be paid off. Eventually, however, someone’s going to ask for their money back, and that’s when all the dominoes fall.

So is the cycle of boom and bust an inevitability, aside from the collapse of market principles altogether? I don’t see how it could be anything but inevitable without another way for money to flow out of the investment sector. Unless someone can enlighten me as to an alternative, it seems like an inescapable aspect of our current implementation of capitalism. Except… there is another way for money to leave the investment sector. Taxes. Taxes are often despised by capitalists because they have a deflationary effect on a market. Having money flow out of a market is generally not a good thing. However, that is precisely the nature of the problem with the investment market that my analysis here reveals. Unless my analysis is wrong then the only thing that can stop the inevitable inflation of the investment market ultimately resulting in massive busts is a complimentary deflationary effect. Taxes. Taxes are the salvation of capitalism.

I’m not suggesting the government ‘redistribute wealth’ out of some sense of egalitarianism. Nor have I mentioned anything about ‘means of production’. This isn’t a Marxist or Humanitarian argument. This is an economic argument. This whole analysis started with a discussion of how important investment is to the effective functioning of an economy. I have made no attempt to demonize capitalists. I have not suggested that this boom and bust cycle is the result of greed or ill intentions. Even if I were to take a Marxist perspective I would argue that investment is it’s own form of labor and should be respected as such. It is simply the case that an investor’s tools are money, his skills are business sense, and his product is actualized potential. A valuable commodity to be sure. However, it seems to be an inescapable truth of our contemporary system of capitalism that it’s very nature is to implode. That statement does not undermine the power of capitalism to match supply with demand. That statement does not suggest that there is another existing system that is better. It is possible that there is a better alternative than our contemporary understanding and implementation of capitalism, that we are missing something, or making a wrong assumption somewhere, but that is a discussion for another day. What remains from this analysis is that the only means of contemporary capitalism to not destroy itself is taxes. The only way to ensure stability is taxes. Taxes, given our contemporary understanding and utilization of capitalism are an essential good necessary for the smooth functioning of our society and our economy. Without taxes the markets for real goods and services will invariable suffocate in debt and the market for investment will invariable inflate and inflate until it implodes. This is not a condemnation of capitalism, it is a statement of fact. Unless I’m missing something vital, taxes are the salvation of capitalism for its own sake, not a necessary evil for ours.