Sunday, February 7, 2010

Speculation: The origins of capitalism and the stock market

Confronted to the abuses that we witness daily in the world of finance, I began last week a series of columns on the ravages of financial capitalism. In the first, I demonstrated the harms of speculation, especially the relationship between it and the economic and financial crisis raging on the planet since summer 2007. In this column, I’ll talk about the birth and evolution of capitalism and oft he stock market, and compare two forms of investment in a high tech company.

Mumford situates «the birth of capitalism and the transition from a barter economy - facilitated by a local and variable currency – to a monetary system with an international credit structure (Mumford, 1950) », in the fourteenth century in Northern Italy. Regarding the stock market, he tells us that «two centuries later, existed in Antwerp, an international stock exchange intended for speculation on vessel armament in foreign ports and on currency. » Others trace the birth of this financial institution at an even earlier time. Some, for instance, report the existence of «courratiers» (ancient form of the French word courtiers), brokers, in Paris in the twelfth century, «concerned with managing and regulating the debts of agricultural communities on behalf of the banks» in France, then for the exchange of state debts by Lombard bankers in the thirteenth century. A first stock exchange is said to have existed in Bruges in the fourteenth century. According to many, According to many, the term «bourse» (stock exchange) origins from the name of the Van Der Beurze (De La Bourse in Walloon) family, the house in which Bruges commodity traders met. However interesting, all these socio-historical references are however little importance in light of speculation, inherent to the stock market.

On this subject, Mumford wrote «international stock exchange intended for speculation »; his use of «stock exchange» and «speculation» within a short sentence and of the adverb «intended» to link both terms and point out the purpose of this financial institution, demonstrates the indissolubility he sees between «stock exchange» and «speculation». Mumford goes on to say that with the advent of financial capitalism, «all business took an abstract form. They did not deal in goods, but in imaginary futures and hypothetical gains (Mumford, 1950). » He continues with the mining industry, stressing that the expansion of operations and use of machinery using the latest technologies of the time, required an injection of capital that the workers could not provide: «This led to the admission of associates who brought capital instead of work: they were silent partners [...] This capitalist development was further stimulated as early as the fifteenth century by the rampant speculation on shares. Landowners and merchants practiced this new game (Mumford, 1950). »

This said, to base human and technological development on a capitalist form of economic organization does not inevitably entail speculation. This practice is not inherent to capitalism, but to human greed; of all times, it has been the doing of a few. It has now reached dizzying heights; creating no real wealth, it only allows a handful of individuals to get revoltingly rich to the point of destroying the system that allowed them to accumulate their wealth. It could be otherwise.

Consider two $100,000 investments made in high technology, the first in a small startup company involved in software development for data security, and the second in a mutual fund speculating on the prices of metals, a critical resource in computer manufacturing. For purposes of this comparison, assume that two investments are worth $ 500,000 after 5 years and that both investors liquidate their respective investment, cashing in a profit of $400,000. Both these investments were equally profitable and will receive the same fiscal treatment, i.e. a tax on only 50% of the capital gain. However, which of these two investments has been most beneficial to society? Which has created real value?

In the first instance, programmers, salespeople and other employees were hired, thus creating collective wealth; furthermore, these people have paid taxes on their incomes to various government and their consumption has fuelled other economic sectors. The value of the small business has increased from $100,000 to 500,000, a value based on tangible assets, although some proportion may be intangible, such as the software developed. Said software has allowed other companies to protect their data and hence operate more efficiently and securely. We should also not forget the fact that the investor will probably not liquidate his investment after 5 years, especially if he owns the business. Even if he did so, the company would not liquidate its assets; under the direction of a new owner, it would continue to prosper, to hire staff and create collective wealth.

In the second case, we can see only a small positive impact on society; as in the first case, merely the imposition of a tax on 50% of the $400,000 capital gain. Quite the contrary, the impacts on society are rather negative. For instance, the rising price of metals affects the development of several companies, raising the prices of several products they need. If the value of investment increased from $100,000 to $500,000, this gain represents no real increase in value, only an increase in the perceived value of metals, the result of speculation on their price. Is the imposition of an identical fiscal treatment to these two investments fair if one considers the benefits to society? Let’s keep this question open for now ... but we will get back to it.

In my next column, I will discuss the financing needs of companies involved in technology.

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