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Sunday, March 29, 2015

Depreciation, Stock, Sustainability and Money

I love boats, and need cars. But both are a pain in the rear end to own unless they are treated as capital assets or capital goods and related to some income generation. The Joke is that a boat is a hole in the water you pour money. The reason this is true is that any kind of machinery depreciates. This got on my nerves when we were doing acquisition projects for the Government. When working with Government program folks we could talk about "sustainability" and "sustainment" but when you talked to the acquisitor project managers their eyes would turn glassy. Both businesses and government depend on institutions with machines, buildings, capital goods, what Adam Smith would have called "Capital Stock". The real Capital Stock of a business are these productive goods.

cap·i·tal goods
goods that are used in producing other goods, rather than being bought by consumers.

Yet you look up Capital Stock in the Dictionary and you get:

Capital Stock
"The common and preferred stock a company is authorized to issue, according to their corporate charter. Capital stock represents the size of the equity position of a firm and can be found on the balance sheet (or notes) of a typical financial statement."

Obviously the two definitions are divergent.

The Capital Stock Bait and Switch

Capital Stock is issued at the Initial Public Offering (IPO) and represents the abstract value of a company. If it represented the real initial investment in the company then it would depreciate along with the assets it represents. Most companies by the time they break even have had almost all their variable capital goods refreshed dozens or even hundreds of times, goods like like generators, printers, computers, other hardware, replenished over a period of sometimes less than a year, and have required maintenance and refreshment spending on fixed goods and buildings as well. In short the initial capital stock under Adam Smith's definition of the term has depreciated and required periodic capital refreshes and the original investment if it were the actual capital of the firm would be gone. A company generates revenue and part of that becomes the real capital stock of a firm.

Thus Capital Stock" is an ownership title to the profits of the firm but doesn't reflect the companies actual capital value except by accident. Since much of the productive value generated by a company is from Capital Goods Plus Labor and raw materials = finished goods sales. The after sales stock values of a Company represent a combination of it's sales and savings on labor or sustainment and can be manipulated. Moreover Profit = Sales - Costs - Debt maintenance so if the real capital investment comes from debt (or stealing wages) then the more debt and the more stolen wages, the higher the short term profit. But since the real value of a company is the depreciated Sum of it's Total Stock - Debt these two numbers don't equal, so this is a built in source of instability.

I think John Turmel talked about this in his videos and I've seen this discussed elsewhere, but this sort of convenient abstraction has real consequences. Companies regularly run themselves into the ground. People like Romney when he was at Bain Capital will buy companies, load them up with debt, extract inflated Capital Stock and sell it high. And then laugh as the company goes bankrupt after they get out of dodge and run for President. A system of ownership that reflects reality would not only be better for stock investors in the long run, but would be better for everybody as our current system has this designed in con of "Capital Stock Paper" representing corporate value instead of the companies "Capital Stock."

An Appreciation for Depreciation

I think this lack of appreciation for depreciation also reflects why our money supply is always unstable and collapsing too. Money loaned into existence to cover investments in sustainment, debt creation and that ignores depreciation creates instability. A business that owes more than it's actual Stock Value (as in Capital Goods) can't pay back that loan on demand. And since money creation is hinged on these sorts of fake calculations too (Stock market paper values aren't the only ones) it's no wonder we have continual instability and collapses.

Creating Money

When Banks pretend to create money from depositor money they really create IOUs (new money) that pretend to be based on deposits but are really just IOUs. Turmel explains it in his article on what he calls the "LETS Banking system" []:

"The famous "reserve ratio" of a "fractional reserve system" sets the limit on the amount of new money the private banks may create. It simply means that a fraction of all deposits is sent to the Bank of Canada's reservoir and the bank is then allowed to turn on the tap to match the deposits remaining in their reservoir. Banks create most of the money in circulation. To go step by step through the fractional reserve banking system's plumbing with a 10% reserve ratio, let the Bank of Canada turn on its tap and put $100 of "high-powered" new money into circulation. Each time a loan is made, the borrower always eventually deposits it into the banking system. "

And he shows how the process allows them to print money:

Transaction:Central BankAccountsIOUNew Money
Deposit old $100: 10 90
Loan out new $90 for $90 IOU 90 90
Deposit new $90: $9 BoC $81 Bank 9 81 0
Loan out new $81 for $81 IOU 81 81
Deposit new $81: $8 BoC $73 Bank 8 73 0
Loan out new $73 for $73 IOU 73 73
Deposit new $10: $1.00 BoC $9.00 Bank 1 9 0
Loan out new $9.00 for $9.00 IOU 8.10 8.10
[............................... to infinity] Src:
$100 $900 $900 $0
Old New New

He then notes:

"Where the system started with only $100, after the expansion is over, the Bank of Canada is holding the original $100 as the banks' 10% reserves and the banks' reservoirs are holding the other $900 of the savers' new deposits. So, $900 newly created dollars were added to the system by the private fractional reserve banks for every $100 issued by the Bank of Canada. This limit is the inverse of the reserve ratio. A reserve ratio of 5% would generate total new money of 1/.05 = 20 times the initial high-powered Bank of Canada money. This is how an ordinary bank creates new money as new loans based not on the production possible but on past savings of money."

How Money is Destroyed

I'll ignore his commentary because the next part is what's important here:

"Just as money is newly issued from the tap when a bank makes a loan, money is destroyed down the drain when a borrower makes a principal payment. Interest payments go back into the reservoir and not down the drain."

And note, as with Corporate Stock versus original capital Stocks (Capital Good) loan repayments don't have any bearing on whether the economy still needs the money, or whether it it wisely spent or poorly spent. It not only vanishes. It precipitates the vanishment of multiples of itself as the banks must reduce their loans due to the reduced reserves.

"When a large withdrawal is made or a large failure is written off the banks' books, the reverse reserve ratio process takes place. Since losses are covered from reserves upon which are based the loans, when their reserves go down, they have to call that amount in loans. It's quite an automatic doomsday mechanism. It was bankers calling in loans which precipitated the 1929 stock market crash. As people fail to meet their call and those loans are written off again reducing the bank reserves, more loans must again be automatically called in. The process gets worse and causes the banking system to fail."

And he notes the risk that this puts any banking system relying on "fractional reserves".

"Any cabal of rich men can precipitate such a "credit crunch" by simply moving their savings to another country which forces the banks in the target country to start calling in loans. Such private power over the world's financial system is inappropriate." "LETS Banking system" []

And of course this is what happened when Andrew Jackson eliminated the third? National Bank. Money issued by private banking notes is inherently unstable. And part of it is because the loans that back note creation reflect capital goods and real wealth and liquidating them to pay debts is suicidal.

The Questions

So the questions become:

One: If reserve banking is inherently risky then why do we require reserves. Wouldn't it be better to force banks to pay a risk premium and treat deposits as a bailment unless specifically turned over for money lending? Turmel suggests that too. [see] Is the reserve banking system really this unstable? If so why is it dominant world wide?

Two: If Company Capital Stock has little to do with the actual stock value of a business and simply represents initial investment long discounted, why don't we have a system of ownership that reflects the actual present value of a company and both receives and rewards refreshment investments systematically and in a way that accurately reflects Stakeholders?

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