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the origins of profit, part 3

Ok, I guess it's hard for me to say "this is the most deep and interesting part of it" and then just skip it and refuse to say more. So I'll bite. What is interest really and is it fair? Or is it usary? I get the sense that this is something which is very deep and has been debated for ages, and is in some sense at the very heart of capitalism.

But before I say something about interest, let me make one more comment about capital gains. Based on my previous post, you might think that, if you believe interest is fair and therefore normal profits are fair, then maybe most capital gains involve normal profits, and are therefore fair. I'd have to look this up to be sure, but I wanted to point out that I *think* the case is exactly the opposite. Most profit levels are abnormal, not normal. Normal would be the break-even point where a business was just on the edge of going out of business. If they slip below the normal profit level then they're not going to find any more investors because the investors will shift into companies making abnormal profits. Also, consider the fact that the long term yield of investing in the DJIA is consistently much higher than the yield on bonds, and yet if the companies that compose the Dow were only making normal profits, you would expect the only difference to be a small risk premium accounting for the possibility that the entire stock market collapses. This doesn't seem to be the case at all, from what I can tell.

Moving on to interest, what is it? Interest can be broken down into a sum of several things. One is inflation, which is interesting in itself but not terribly relevant here. Another is a risk premium which depends on how likely it is that the borrower will default on the loan. Another is a liquidity premium which depends on how easy it is to immediately demand your money in the form of cash (for example, you will get a higher interest rate on a money market than a checking account because it's harder to get the money back immediately, and an even higher rate on a CD where it's almost impossible to get the money back ahead of time). And then left over after all of those factors in the sum is just a raw number which seems to indicate something like the compensation for a person "not using" their money, and instead letting someone else use it for a while.

If you make an analogy to rent, then this leftover factor seems to make sense. If you're not using your house, you can rent it out to someone else for a while and they will make regular payments. So why not do the same for your money? But two things should be mentioned here. First, even rent was considered by many classical economists, including Adam Smith I believe, to be "unearned income". And in light of more modern economics, it seems only fair to the extent that the person has legitimately acquired the house through their own blood sweat and tears. If instead they simply inherited the estate (whether house, land, or money) from their ancestors, as tends to happen within many rich families from one generation to the next, then it's not true that they did anything to earn it although perhaps their ancestors did. And if you trace the ancestory back far enough, you may find that the land was acquired by conquering some other people, or that the wealth was built up through slavery or other unfair practices.

But even assuming that all of the ancestors at some point legitimately built up the wealth or the land from their own labor power, and assuming modern neoclassical economics (at least at the micro level), it still seems like there might be something a bit different about money than land. If I own a house, then there is some tangible good that I could otherwise be getting real use out of, raising a family in it perhaps or starting a clothing factory. But if I own money, all I have is a number in my bank account, or at best a physical piece of paper. It's not anything anyone can use directly, its only use is supposed to be as a placeholder for value. It's supposed to be something that I can trade for something with actual value that I can use. Money is not something tangible, it's more like a right or an agreement. Money is a legal document that gives me the right to have power over other people or over my environment. It's something that grants someone more freedom. When I then take that and use it to convince someone else to give me even more money, but I don't have to give up the original money in the end... what just happened other than using your power over someone else to extort them into giving you even more power?

Marx criticized capitalists for reifying money into something tangible and I think there's both something insightful about that but also something that seems shortsighted. I want to say that there shouldn't be much of a difference between tangible assets and intangible assets, as society becomes more and more virtualized. The lines between physical and virtual are disappearing, and for the most part that seems like a good thing, not a bad thing. But there's also something naggingly right about the basic point. Is it fair or is it not fair to use your money to get even more money from someone else and keep all of the original money? And once you have more than the basic amount of money required to live a comfortable life, are you actually giving up anything by investing the rest of it to get even more of it? It seems like a no-brainer that you would.

Then there is the awkward and bizarre issue that if interest is really some sort of compensation for giving up something, then there ought to be a relatively straightforward way of determining what the "fair" interest rate is to charge. And yet, interest rates are not really determined by the free market, they are simply set by the Federal Reserve. What rate they get set to depends on what the people in charge want the economy to do, not on any measure of fairness... if the fairness of capital gains depends on the fairness of interest rates but the interest rates are not set based on fairness, where does that leave us?

Continued in part 4...

Comments

( 1 comment — Leave a comment )
keiferlawson
Nov. 16th, 2012 05:15 am (UTC)
Real Estate Investment is a stable business for those who want have their own business and would also like to handle it by themselves. A true business that would give you high income.
( 1 comment — Leave a comment )

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