The Stock Market, Credit and Capital Formation

CHAPTER IX

CAPITAL GAINS, SAVINGS AND A VICIOUS CIRCLE

65. In the course of the previous chapters we searched every nook and cranny of the stock exchange to see whether money, or capital, or credit might be hidden away there instead of passing straight on into the hands of producers who want it for investment purposes.

It may be useful to recall very briefly some of the problems that have so far been investigated. Among the questions we tried to answer were these: Do speculators need to hold large idle balances? Is it necessary for stockbrokers to keep large bank balances in order to deal with a heavy turnover? Are large sums of money tied up in stock exchange transactions in the process of passing from hand to hand, or from one banking account to another, when speculators carry out a series of selling and rebuying operations? Do capitalists accumulate large sums in their banking accounts when share prices rise unduly high? Do speculative gains lead to wasteful spending and hence to capital consumption? Do speculative losses cause funds permanently to disappear? These and many other problems have already been examined.

Now Mr. Harold G. Moulton tells us that in the years 1923–29, many billions of dollars worth of “savings available for investment” disappeared. The amount lost is estimated at from three to four billion dollars per annum in the early years and as much as 10 to 11 billion dollars per annum in the later years of that period.1

Many billions of dollars reported as missing.

This is indeed an enormous sum. It represents such a large proportion of the total circulation of bank money that the idea of such a gigantic “volume of money flowing into investment channels,” and, according to Moulton, never reaching the hands either of producers who want to invest or of the public who want to spend or hoard, is quite startling. It needs to be inspected more closely.

66. How did Mr. Moulton arrive at his estimate of these lost billions? He made an estimate of the national income, subtracted from it the amount spent on consumption, and called the difference “savings.” He then estimated the amount invested in “new plant and equipment” and discovered that much more had been saved than had been invested.

National income minus consumption was called “savings,”—

The reason why other statisticians did not discover this remarkable deficit, was that they used a different method of estimating the national income. The method they adopted was simply to add together consumption and investment. Mr. Moulton, however, calculated the national income separately by another method, and then examined the figures to see if all of the income was consumed or invested. And so he discovered the remainder.

The savings, that is the national income minus consumption, were available for investment. Actually, however, they were not invested, because, as Mr. Moulton explains, producers in general are rather cautious and are anxious to avoid over-investment. This means that they do not want to expand their productive equipment faster than the demand for consumers’ goods expands. In consequence a part of the savings was left uninvested.

—which were not all invested,—

In Mr. Moulton’s own words: “the supply of funds available in the capital market increases faster than the flow of money through consumptive channels; and yet at the same time . . . the amount of new plant and equipment does not increase appreciably faster than the demand for the goods which such capital can produce. The question, therefore, arises, Where do the funds rendered available in the capital market go if not into the building of excess productive capacity?”2 and: “When the volume of money savings is in excess of the requirements for new capital construction, what becomes of the excess?”3

—because they exceeded investment demand.

The funds seeking employment are not invested; nor are they consumed, nor are they hoarded.4 What then does happen to them? “They may be loaned abroad,” or, and this is the main point, “They may be used in purchasing securities already in the markets, and be absorbed in bidding up the prices of such securities.”5 Thus the “excess savings” were “absorbed” or “dissipated” in “bidding up the prices of outstanding securities.”6

It is alleged that these “excess savings” were neither invested, nor consumed, nor hoarded,—

—but absorbed in bidding up security prices.

67. The way in which the “money savings” or the “investment money” are supposed to be “absorbed” by a rise in stock prices is not at all clear. If a billion dollars has been used to buy existing securities we may search, all the alleged possibilities of absorption, but somebody must always have the billion dollars: it may be the sellers, or the brokers, or a second set of sellers, or a third set of sellers, and so on. In any case somebody must have them unless they have gone out of circulation through the repayment of bank debts. But nothing of this has anything to do with stock prices. If stock prices were bid up very high, the buyers would get fewer stocks for their money, but one billion dollars remains one billion dollars no matter whether the buyers receive 20 million shares or only 10 million shares for them. If in the absence of the rise in stock prices the billion dollars would have bought 20 million shares, but in consequence of a doubling of stock prices they buy only 10 million shares, what sense is there in talking about half a billion dollars being “absorbed”? How much of the billion is invested, how much is consumed, how much consciously hoarded, and how much is tied up in carrying out stock transactions, are all serious problems. But it is meaningless to ask how much was “absorbed” in “bidding up the prices.”

Must it mean absorption of funds if one gets fewer shares for one’s money?

The rise in stock prices is, however, very closely connected with Mr. Moulton’s absorption theory. For if we examine the method of calculation which gave the remainder of uninvested savings, we find that we are not really dealing with “money savings” at all, but that, in estimating the “national income,” the capital gains (i.e., the realized appreciation of stock values) were counted as part of this income whereas they were not counted in the estimate of investment. We see then that the capital gains were not really lost, or at any rate not to the people of the United States, but only lost in the shuffle by Mr. Moulton.

Mr. Moulton counted the capital gains as part of the national income. Any statistician or economist has a perfect right to do this, particularly when dealing with problems of taxation and of equity in the tax system, &c. But if we want to use the resultant estimate of the national income for estimating the amount of capital formation we have to be wary. Capital appreciation cannot be invested because it bas already been invested. Capital appreciation, no matter whether it has been realized through the exchange of property between different persons or whether it only exists in the form of mere “paper profits,” is nothing else than the higher valuation of past investments. These changes in the value of past investments may lead the owners of the investments to consume more or less of their current money income (i.e., income not including the change in valuation of capital assets); but the changes in value of the assets of the community as a whole cannot in themselves be either consumed or saved or invested. If we want to count the increase in the value of assets as income, we must, of course, consider it as invested income. In other words, if we count changes in capital values as part of the national income, we must count the “capital formation” of the relevant income period as the difference between the total of capital values at the beginning of the period and their total value at the end of the period. For most economic problems this does not have much sense, and for that reason appreciation in capital values, or capital gains, are not usually counted as part of the national income in considering questions of capital formation.

If capital gains are counted as part of the national income, it must be as part of invested income.

Mr. Moulton is obviously the victim of looseness of language. For after the capital gains had become “income” and after the income (minus consumption) had become “saved income,” the “saved income” was simply and inconspicuously translated into “money savings”7 and then into “available investment money.”8

Such “saved income” does not constitute available money savings.

The effect of this confusion of terms may be made clear by some examples. Let us assume that Mr. A saves $1000 and buys shares for this amount from Mr. B. Mr. B consumes the whole of the sales proceeds. While it is now quite clear to us that Mr. B has consumed what Mr. A saved so that there is no net saving, Mr. Moulton would go on to ask what the shares cost Mr. B when he bought them. And if Mr. B had obtained them at one time for only $400, Mr. Moulton would at once declare that there had been a capital gain of $600. And these $600 would be “saved income” because, in addition to the $1000 saved by A out of his income, B received an “income” of $600. Only $1000 was consumed, however, so that $600 must have represented net saving, but are these $600 really available to Mr. B or to anybody else as “money savings”? Surely not. Mr. B received $1000 and spent the entire amount. Nobody has the $600 in the form of “available investment money.”

Capital gains are not money income to society,—

—and cannot be consumed or invested.

Now let us vary our example by supposing that Mr. B, who receives the $1000 “money savings” from Mr. A, invests the whole of it in his business by buying new plant and equipment. For income tax purposes and for Mr. Moulton’s statistics Mr. B’s capital gains must still be put at $600 as before. From our standpoint $1000 would have been saved and $1000 invested in this case, but Mr. Moulton would add the $600 “income” of B to the $1000 saved income of A, and would then hold that only $1000 of the $1600 “investment money” had actually been invested. The missing $600 would be said to be “absorbed.”

68. The case is seen in all its crudity if we suppose that the seller of the shares uses the whole of the sales proceeds, i.e., his original investment plus capital gains, for purchasing other securities and in this way creates further capital gains. Then total “income” will rise with every additional transaction that takes place, and, according to the Moultonian method of calculation, the total of “excess money savings” that are absorbed will rise in a “vicious circle.”9

Let us assume that A has saved $1000 and that he buys shares from B. B uses the whole of the $1000 to buy shares from C, C uses the money to buy from D, D from E, E from F, and F finally invests the $1000 in his business. An adherent to the theory that money is temporarily absorbed in stock transactions would say that the $1000 was absorbed from the time when the shares were purchased by A to the time when F used it for purposes of real investment. (I have tried to show that even this would not be the case if all of the transactions of Messrs. B, C, D, and E were settled through their brokerage deposits.) But what would Mr. Moulton say? If Messrs. B, C, D, E, and F had all paid $400 for their shares when they bought them, they would each make a capital gain of $600. According to Mr. Moulton, there would be $3000 of “absorbed, dissipated money savings.” For he would calculate that apart from the $1000 of A, the $600 income of each of Messrs. B, C, D, E, and F had been available for investment, making a total of $4000. $1000 of this sum was used for “new plant and equipment.” An amount of $3000 “excess money savings” would thus appear to him to have been absorbed “in bidding up the prices of outstanding securities.”

Repeated securities transactions may create a “vicious circle” of capital gains,—

Mr. Moulton’s theory boils down to the following: one calculates the capital gains due to rises in security prices, calls them income, and then complains that this income is absorbed in rising security prices. The “vicious circle” which Mr. Moulton thought he had discovered turns out to be simply one of his own reasoning.

—and capital gain are “absorbed” by definition.

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