Monday, September 10, 2007

[Latest Global Dollar Liquidity Measure: +13.4% annual growth rate; latest Endogenous Liquidity Index: -31.4%]

Steen Jakobsen, the cautious Saxo Bank fund manager, recently mentioned Joseph Schumpeter, writing: "Destruction of capital is the name of the game". Instinctively, I went back to my bookshelf, and to one of my most prized possessions: a 1951 edition of the Encyclopaedia Britannica. Volume 4 contains a long article by Schumpeter on "Capitalism". I don't have it right now with me, so let me quote it from Thomas McCraw's recent biography (*):

"A society is called capitalist if it entrusts its economic process to the guidance of the private businessman. This may be said to imply, first, private ownership of nonpersonal means of production … second, production for private account, i.e., production by private initiative for private profit." He went on to say that a third element is "so essential to the functioning of the capitalist system" that it must be added to the other two. This third element is the creation of credit.

The core ethos of capitalism looks constantly ahead and relies on credit and launching new ventures. From the Latin root credo—"I believe" —credit represents a wager on a better future. The entrepreneurs and consumers who make these bets often care little about the past and have scant patience with the present. They undertake innovative projects and make expensive purchases (houses, for example) that require far greater resources than those lying at hand. In the absence of credit, both consumers and entrepreneurs would suffer endless frustrations.

Are we about to witness a period of destruction of capital, on the heels of a phenomenal wave of financial innovation? If funding and market liquidity indicators continue to deteriorate, this is a distinct possibility.

(*) Prophet of Innovation: Joseph Schumpeter and Creative Destruction. Harvard University Press, 2007 (read the prologue).


Anonymous said...

"Are we about to witness a period of destruction of capital, on the heels of a phenomenal wave of financial innovation?"

Galbraith: there's no such thing as a financial innovation.

There's debits, credits, and leverage. That's it. Too much leverage, too much debt, credit being destroyed. It's all happened before. Your belief in 'financial innovation' is telling.

What you thought spread out risk, in fact spread opacity and increased risk at the end of the day.

It's the end of the day, btw.

Anonymous said...

Agree 'financial innovation' is an oxymoron.

There is risk. Even if you rename things or play around with tranches of this and that, or run complex mathematical programs that show how risk SHOULd be reduced- in the end the risk is still there.

By camoflaging it, it allowed speculators to leverage themselves in to more of it, that's all.


Agustin said...

I beg to disagree. Nobody said that credit risk had disappeared, only that it was better diversified. Two steps forward, one step backwards: that's the way humanity makes progress.