19 February 2010

Quaint Victorian Notions About Capital in a Modern World

We Americans live in the richest, most economically driven country in the history of the planet. And still we’re ambivalent about money and debt. Our revulsion to debt is literally Victorian.

There was time in history when capital was scarce and hard to get or create. Social inventions that helped to overcome this limit made communities rich. Social inventions included new norms, like traditions of saving and investing, and new institutions, like modern banks, and bond and stock markets.

One of the social inventions that helped in the early days of capitalism was uneasiness about debt, something shared by British and Americans in the 1800s and early 1900s.

19th century preachers inveighed against debt, teaching that it mars and stains the soul. Protestant preachers liked to quote Paul, "owe no man anything but love." Debt was proof that one failed at self-denial. Charles Spurgeon, the best-known English preacher of the late 1800s, described the trinity of evil as "debt, dirt, and the devil."

And yet by the early 1900s, debt had become obviously essential to economic progress. This is still a point little appreciated, it seems, but it has to do with establishing new industries. You'll have to follow a few steps here, but I'll try to keep it simple.

1. Imagine a world where everyone has to farm to be fed.

2. Then, someone invents a machine (capital) that can do the work of 100 men. This means that 99 men are freed up to work on something else.

3. 99 men are unemployed. 1 man is incredibly rich. Or would be, if only the 99 hungry and unemployed men had money.

4. Inventors and entrepreneurs create new products and services – from the sublime to the silly. [Look at the end of this post for a list that comes from the years around 1900.]

5. These inventions and business ventures require financing. Debt even. Debt creates. Getting these new industries started is an act of faith. It requires capital investment for building factories and stores. It requires capital for making payroll to manufacturing and sales people. And it requires consumer credit so that people can begin buying this new thing. Once established, though, capital gets its return and there is a new source of sales and salaries. Debt can create new wealth. And yes, even consumer debt that isn't obviously directed at creating wealth can be instrumental to this.

6. These new ventures and inventions don’t just make life more interesting, richer, and confusing: they create jobs for the 99 people made redundant by productivity gains in the old industries.

All this to say that reluctance to take on debt can hobble progress. One of the worst things you can do in an economy is treat what is scarce as abundant and what is abundant as scarce. Victorian England - with its social stigma against debt - was actually creating the right culture for that stage of capitalism. Capital was scarce and people should have treated it carefully. The reality behind the billions made in venture capital, junk bonds, and credit cards today, though, is expressed in Michael Milken’s observation that, “In an industrial society, capital is a scarce resource, but in today’s information society, there’s plenty of capital.” Today, jobs are scarce and capital is abundant; an economy that goes into debt because it is mis-using its capital but creates jobs so as not to mis-use its labor has an edge over an economy that leaves a large percent of its work force under- or unemployed.

So, with all the worry about debt, what does this suggest? To me, this change suggests that we ought not to worry about wasting capital that is abundant. Rather, we should worry about wasting labor. Our economy will be made stronger by employing more people into productive ventures, not by avoiding debt. Once we’ve got employment back up and have created jobs, we can worry about debt. But not about eliminating it – just in shifting it into the creation of new industries and services.

Some of the inventions from the decades around 1900:
central heating; the safety razor; stainless-steel implements; the striptease; the electric toaster; iron, oven; sewing machine; dishwasher; electric elevator; dial phone; portable typewriter; radium treatment for breast cancer; heart surgery; the psychiatric clinic; contact lenses; toothpaste in tubes; motion pictures; musical comedy; the gramophone; volleyball and basketball; the Ferris Wheel; the jukebox; breakfast cereals; milk delivered in bottles; packaged produce; Coca-Cola; margarine; the ice cream cone; the refrigerator; public libraries; the correspondence course; the full-range department store; the chain store; the shopping center; the coin telephone; the traveler’s check; fingerprinting; the automatic pistol; the electric chair; the automobile and the airplane; the underground city subway train; the pneumatic tire; color photography; rayon and other artificial textiles; chewing gum.


Mark T said...

Ron, reading this article is like listening to the sound of one hand clapping. You didn't talk about investment at all. It seems to me investment and debt need to go hand in hand :-)

You say reluctance to take on debt can hobble progress. And yet, what has Congress been doing for years other than enthusiastically taking on more and more debt? Us citizens haven't seen anything good come from this debt because Congress did not "invest" that debt wisely. Instead, Congress spent it pandering to voters.

"Strategic" debt does make sense. Most people would not be able to purchase their own home if they couldn't go into debt to do so. But "stupid" debt (like borrowing money to go on vacation) should be avoided at all costs :-)

Ron Davison said...

I guess I would say that for the entrepreneur selling vacations, the household taking out debt to go on a vacation wouldn't seem too stupid. It might even be necessary.