A firm usually has many more customers than employees. This is typical of a modern economy as a societal realm: its networks are bigger than its organizations, i.e. the markets are bigger than the firms. This has not prevented some multinational companies to grow very large and rich; some have more employees than have small states, and several are richer than the poorest states. Contrary to much libertarian thinking and particularly contrary to Ayn Rand’s doctrines, it is not individualist systems of pure market transactions that create most wealth. According to our Proposition about The Netorg System of Realm Expansion, “networking organizations”, i.e. corporations working in markets, are the most successful.

This Proposition also makes clear that firms stagnate and become defensive rather than expansive when they grew into monopolies or near-monopolies that become more or less immune to market forces and crowd out the market from the economy.

A Note on Corporate Leadership

Corporations are run by a leadership that includes a Chief Executive and a Corporate Board. A modern board has members who represent shareholders as well as members from the outside society.

An ideal corporate board should have creative and constructive members who are totally committed to look out for their corporation and not for themselves, members who make an effort to know the situation of their corporation and its branch. The ideal board may include someone knowledgeable in business history who can see when old stupidities are revived. Corporate boards may also have use for some skeptic from “the school of hard knocks,” (or from science or journalism) who can reveal argumentation which is more persuasive than sound. Also, a board needs members who are totally unimpressed by well-known persons from firms that have made much money on upticks when they think that they are competent to handle any downturn or off-beat situation. Consider also in recruitments to a board what a difference ethically responsible people can make to the quality of board decisions, be these persons morally gifted by nature, or persons who have struggled enough with issues of honor to become moral virtuosos. But such a member should not be put there for his or her PR-value. Lehman Brothers had apparently little moral help from a board member who was a former head of The Red Cross.

Recent events tell that corporate boards ought to have a member or two who understand politics to the extent that they can grasp the consequences of misguided bipartisan efforts to promote home ownership. One can also imagine what difference it would have made during the build-up to the 2008 financial crisis to have had a board with a member with enough mathematical skill to analyze a derivative equation and put reports and promises by salesmen of derivative bonds to task.

When all is said and done, there is no substitute for a board member’s good judgment. The good board member is not bound by prestige: If you do not know, you can ask. Any board member of a financial institution in Switzerland or elsewhere could have asked about the risks of American derivative housing bonds when the proposal of acquisition of such securities reached their board for final approval. When told that the risk had been calculated both by the issuer and the rating agencies by David X. Li's “Gaussian copula function,” the good board member could have asked about this formula. The answer would be that this formula in one and the same number summarizes all risks for the security. Yes, the same number for risks in both upturns and downturns. Yes, the same number for the risk assessment of these bonds is valid both when the prices in various local markets are different and when they rise or decline in the entire USA. The inquiring board member should then have had little difficulty in concluding that his institution was dealing with a charlatan.

Such a board member did not exist in reality. Much good recruitments are blocked by a special criterion for new members of a typical board. It is considered essential that the candidates are reliable and trusted by the other board members. The candidates are simply not chosen if they question the extraordinary compensation packages that prevail for the leadership in modern corporations.

Functionaries in the Economy

Entrepreneurs are the Makers of new wealth, a creative breed of people. Without them most of us would be poor.

The foremost Keepers or custodians of wealth have traditionally been bankers. Banking is a keystone in the economy, both in centrally planned ones and market economies. Bankers are popularly known as people who lend umbrellas in sunshine, and ask for them back when it rains. Thus they make the cycles of fortune for entrepreneurs, traders, and consumers easy in good times but harder in bad times. They are not always a major cause of business cycles, but as a rule they make them worse. The bankers are balanced by their cousins among the Keepers, the insurers, who collect premiums in good times and pay out when disasters happen. These conventional images of bankers and insurers have become less valid. Shortly we shall show how their own entrepreneurship and inventiveness have changed the roles of bankers and insurers.

The Brokers, wholesale or retail, are responsible for making the economic world go round. Trade, not raw materials, farms, or factories, is the fundament of a market economy. If and when trade is in place, the extraction of raw material, farming, and manufacturing can flourish.

Many carry an image that the manufacturing factory is the basis of capitalism. However, organization of factories for production of goods is a mark of industrialization, not capitalism. Capitalism depends on trade and markets, not only on factories, which are found also in pre-capitalist and socialist economies.

The Cardinal Value of Wealth

The realm of the economy in a society rests on exchanging sentences that include executive evaluations such as prices and costs. The economic realm is dedicated to creating, preserving, and using wealth. There are different paths to wealth, and competition is the stuff of business. Today business practice includes record keeping of all transactions, for example goods and services that have been bought or sold, as well as standardized measurements of profits, capital, and cash flow. In this sphere one seeks freedom of trade, the right to establish one's business where one wants, to do business with all kinds of products and services and over all boundaries.

Figure 20.3. Semiotics of Wealth

To learn more about wealth let us place it in a semiotic square along with its opposite, poverty, and its degeneration into swindling and miserliness (Figure 20.3). Let us first consider wealth and its measure in the form of money.

Wealth

Wealth and poverty are opposed. Both can be expressed in absolute or relative terms. To have exactly a million dollar in 2006 (the time of this writing) makes you just so rich in absolute terms. In relative terms you are then one of 8.3 million dollar millionaires in the United States. In this case there are 2.8 percent of the inhabitants of the United States who are richer than you. If the number of millionaires decreases or increases your relative wealth becomes greater or smaller, but your absolute wealth stays the same. Likewise, if you move to a poor country with your million dollars, you become a much richer person in that country than in your American home country. A person or a group of persons may become richer in absolute terms but poorer in relative terms. Or poorer in absolute terms but richer in relative terms. The failure to specify which kind of wealth and poverty we are talking about has caused confusion and needless acrimony.

Most people see riches as the number of rooms you have in a house, the size and make of your car, the content of your jewelry box, and the elaboration of you dinner menu, the quality of the services you enjoy, and other visible matters. But technically speaking, wealth is not things or services but the evaluation of them. In any advanced society wealth is evaluated in money, and money is measured by a currency scale. 

A currency scale has equal and interchangeable units; a dollar is a dollar at the low end of the scale and at the high end of the scale. And there is a fixed zero-point; it shows that someone has no dollar to his name or that a firm has no cash and assets of its own left, i.e. is bankrupt. No scale of honor is so precise.

No other realm in today's society has scales of its cardinal values with zero-points and equal and interchangeable values. In the body politic there are approximate quantitative measures of power according to the number of votes for a politician and his party in elections. In science there are the count of the number citations received by a professor and his laboratory in scientific journals. However, political power and scientific competence also have other sources than popular votes and citations; here ratings must be supplemented by "good judgments" of those in the know. In the economy, by contrast, you can establish the net worth of an individual or organization and express it in a currency; you need no other information. In the case of firms, quarterly and annual balance sheets, certified by accountants, do the job. This is an obvious advantage for the economy in the ever present competition between societal realms.

The currency scales of evaluation employed in the economy are different and more sophisticated than scales of honor and achievement used in other societal realms. The former draw on the language brain like the others, but it also uses the mathematical brain. Economic evaluations are expressed in symbols that can be treated in arithmetic operations by producers, tradesmen, and consumers, and also by more advanced mathematics in finance. This fact has lent a special aura to the economic realm in society that is not necessarily commensurate with its relative contribution to society.

Money has long has been a universal unit of exchange in everyday life for individuals, households and organizations also in the realms of polity, science, art, religion, and welfare. People active in science, the body politic, art, religion, and welfare are rewarded both by honor and by money. In business there are few honorific rewards, and the reward system is in effect based on money and money alone. Government officials, scientists, artists, priests, and welfare executives have total rewards that consist much less than 100 percent of sheer money; the balance is honor. When rewards in the economy being practically 100 percent money are compared to rewards in the non-economic realms, a sense of resentment is close at hand. We can, for example, expect much public anger directed at extensive “compensation packages” for top management in those modern societies in which politicians and labor unions have destroyed the honorific reward systems in the name of equality.

Poverty

 Poverty as we have come to perceive it, say, in large parts of Africa and on the Indian subcontinent of Asia, has been the normal state of mankind throughout its entire history. Wealth have been very spotty and found along some fertile river valleys, trading cities, royal courts, and aristocratic mansions. The eradication of poverty on a larger scale has a history of only some 200 or 300 years.

As part of its millennium goals for mankind the United Nations expressed that the number of poor be reduced by half by the year 2015. All member countries and all the world’s leading development institutions agreed on this goal. Living under one dollar a day was used to define poverty. This is an absolute measure, but ambiguous; the dollar fluctuates in purchasing power, and the definition of the poverty level must in principle be adjusted every year.

Poverty, like wealth, is expressed either in absolute or relative terms. Paucity may be reduced from one year to another in absolute terms, but increased in relative terms. Relative poverty depends on the rest of the income distribution. To measure poverty in relative terms you may ask for the percentage of total wealth that is possessed by the lowest ten (or some other low number) percentiles of the population. The United Nations did not declare any goal for the reduction of relative poverty in the world.

The world average of absolute poverty is being reduced at a rapid rate, not because any UN directive, but because institutions of private property, rule of law, and freedom of trade has allowed entrepreneurs grow in number, hire many, and pay wages high enough to raise entire households over the poverty level. At the time of this writing, it is primarily due to China's rapid development that the world figure on reduced poverty shines.

Swindlers

Looking to the right side of the semiotic square of wealth (Figure 20.3) we meet economic swindlers who engage in deceptions for personal gain. The oldest form is the use of counterfeit money. In a typical modern con game the swindler is not as rich as he (or she) pretends, and the presumed wealth is used to draw those who are richer into schemes that transfer their money to the swindler. F. Scott Fitzgerald novels The Great Gatsby and This Side of Paradise revealed swindling and questionable identities on more than a petty scale.

Personal greed may not be the motor of capitalism, but it is the sure source of corruption in capitalism, as it is in other systems. The long version of the tenth commandment reads: "You shall not covet your neighbor’s house; you shall not covet your neighbor’s wife, or male or female slave, or ox, or donkey, or anything that belongs to your neighbor." If it had been written in capitalist times it would have included another clause: "You shall not covet the cash flow of your employer, or his suppliers, or his customers." Top management of other people's factories, offices, wealth, and assets are the new robber barons. In the first half of the twentieth century they began to replace owners as day-to-day leaders of firms (Berle & Means 1933). In the second half of the century they formed the majority of most corporate boards. This made for professional governance by graduates of business schools. It also paved the way to the practice of non-owners to give fanciful "compensation packages" to each other. To covet the cash flow of one's employer is an ever present temptation to enrich oneself, for all employees to be sure, but particularly for modern management.

A swindling process that became highly visible in the United States about a half century ago has spread to other capitalist countries. Though a process of institutionalized evasion of norms it has become widely acceptable. The boards of the larger corporations and their chief executives is a network, as described in Chapter 6, that is formed around a common identity of participants. This particular network has developed into an informal Fortune Creating Circle that anoints (i.e. installs and blesses) their members with fortunes. These fortunes are built by regular honoraria and salaries, perks of many kinds, year-end bonuses, stock options, huge pensions, and/or anything else that may fit compensation packages. In recruitment processes to the top, the issue is always raised: “Can we trust him (her)?” This query may be a code for several things; it always includes, explicitly or implicitly, the candidate’s loyalty to the general level of compensation and its annual rises are current within the Fortune Creating Circle. In early capitalism you had to be the owner-entrepreneur to reach high fortunes. In the mature capitalism it is enough to be top management and/or board-member.

Critics call the Fortune Creating Circle “a culture of greed.” *Government officials who are set to run socialized enterprises are rapidly drawn into its reward system. The same seems to be true when official from labor unions join the boards and participate in the setting up of compensation packages for executives and fellow board members

With the advent of money documented only in computerized accounts, economic swindling of big corporations and government institutions has become easier for the technically proficient. The possibility to have inappropriate transactions outside of balance sheets without mentioning them in footnotes — sometimes in collusion with accountants — provides a golden opportunity for high-level corporate swindlers.

The borderline between sophisticated banking and swindles became blurred when firms on Wall Street  invented a combination of "derivatives," "securitization," and "off-balance-sheet accounting with special purpose entities". *They were innovative financial products that unexpectedly crippled the world's banks in 2008.

Anything that has reasonably regular payments — installment debts on credit cards, mortgages, car loans, aircraft leases, toll payments at super-highways, music royalties — has long been used as collateral for a an advance in the form of a loan. An innovation is to make such transactions by securitization. A trust is set up by a bank to receive the money from such collections. The trust issues bonds and pays bondholders interest, and at the appointed time, the principal. So far so good. Combinations of mortgages from different districts and from home owners with different credit ratings can be combined and packed as a "derivative" and also sold as a bond. Obfuscation is close at hand with securitization of derivatives. Here starts much trouble. The risk and value of such bonds is in principle calculable, but in practice difficult to calculate. A swindle begins with an assertion to the buyer that there always will be a market and a fair price for such securities.

The trust, or what remains of it after initial sales of any bonds, may get off the books of the bank by including it in a so-called special-purpose entity, preferably incorporated in a low-tax place such as the Bermudas or Cayman Islands. With this innovation in off-balance sheet accounting, the bank no longer eats into its capital requirement for further lending. The bank merely books profits from such lending transactions. It does not have the normal costs for increasing its base of own capital when lending more, nor the risks of defaults in the stream of payments from credit cards, mortgages, or whatever was included in the trust. 

Is securitization of derivatives combined with off-balance sheet accounting a swindle or just financial inventiveness? Joseph Stiglitz, professor of economics at Columbia University, had his view formulated at the beginning of the bank crash of 2008 when on October 21 he told a congressional committee, that this "securitization was based on the premise that a fool was born every minute. Globalization meant that there was a global landscape on which they could search for those fools — and they found them everywhere."

Most of these fools born every minute have birth certificates in the form of MBA-degrees from business schools. After the turn of the century there has emerged an unfortunate conformity in curriculum and attitudes of the business schools and their student bodies. Business school graduates the world over were given unrealistic birth rights to expect excessive compensation packages. But the main problem with these schools is wider.

In a Many-Splendored Society an MBA-degree should be considered de-meriting until the business schools learn, not only to better separate swindling from wealth creation, but learn to better see business and economy as a part of a total society in which other societal realms are their equals. To get rich is not anything superior to the holding of political office, have scholarly competence, deliver artistic beauty, or to carry sacredness or virtue to your community in the course of every-day living.

Misers

Looking to the left side of the semiotic square of wealth (Figure 20.3) we meet misers. The typical miser hoards gold and other symbols of rich and does not spend money on investments or charities. Misers are stingy also when it comes to buying comfort for themselves. They do not want to reveal that they are wealthy.

It is not illegal to be a miser. Morality rather than law is invoked to cope with miserliness. But the moral message is mixed. Many moral doctrines actually say that it is better to save money than to spend it. But are hoarders of money actually nobler than spendthrifts? On a personal level they may or may not be. But on the societal level they are not superior according to the rationality of economics. A nation of misers is not conducive to economic growth; too many trades that add to wealth are simply left undone. People do not notice businesses that do not start so we never know the damage done by misers.

Moral doctrines that affect misers hold that you must share your wealth with the poor. Dickens' master miser, Ebenezer Scrooge, is rewarded with happiness when he finally does so. However, there are also moral arguments to the effect that providing workfare is better than providing welfare in the form of the dole. A job gives a person new social encounters at the workplace. It gives discipline to the individual. It gives taxes to the body politic, something appreciated by politicians. Public welfare carries big costs for the body politic. But welfare legislation gives its promoters among democratically elected politicians many votes.

Philanthropy is not the same as charity. Charity is giving to people who are without food, clothing, shelter and the other necessities of life. Philanthropy is giving donations to projects and institutions within the areas of culture, science, religions, health, and others that lack sufficient sources of revenue from taxes or sales. Philanthropists can be private citizens, non-profit organizations, companies, or foundations. Individuals may donate their time as well as money. Their names may appear on bronze plaques in buildings, on a page in a theater or concert programs, in the title of a professor’s chair, in the Foreword to a technical book, next to an exhibition in a museum. Foundations are the most sophisticated forms of modern philanthropy.

Tax legislation is decisive to philanthropy. In the United States at the time of this writing, a philanthropic foundation must give five percent of its total resources (capital, interest, dividends, and capital gains) annually according to its charter, or, send this money to the tax authorities. Interviews carried out among the many private individuals in New York who are philanthropists (Ostrower 1995) included a question as to whether the deduction for contributions should be eliminated and let the state use the additional tax revenues for the philanthropic projects. One of the respondents answered “If I wanted this I would move to Sweden." Any country sensitive to the detailed needs of its population should have legislation that encourages and facilitates philanthropy. Ministers for culture, research, health, and education may assume omnipotence and promote the idea that they, themselves, can meet all needs of their society through political channels. Surely they can do much, but we can extend  a well-known thesis thesis – Hayek (1954) – and say that they don’t have information about all that has to be done. There is always room for private philanthropy.

Property Rights

The economy is a continuous exchange or distribution of belongings, or rather their representations in the form of property rights. The most common exchanges are between money, on one side, and titles to goods or of services, economic or personal, on the other side.

We know from our discussion of Hohfeld (1913) that any right is defined by four conditions: claim, liberty, power, and immunity. The ‘claim’ is an explicit expectation that others should accept my actions. The ‘liberty’ is the expectation that I have other options and am not forced to do everything I have a right to do. The ‘power’ is that I am allowed to do it as long as it does not violate the rights of others. The ‘immunity’ is the expectation that others will respect these rights of mine. These four expectations in exchanging goods and services are formalized in the right-hand column of the dialog below. We recognize them as one of the most important impelling vocabularies of contemporary living. We discussed them in Chapter 11 and exemplified with the right to learn English.

In the left-hand column below we record everyday words in a dialogue that takes place when we buy a car from a car dealer In the right column we enter the needed analytic concepts. We use X=buy/sell a car.

In the right column we have Hohfeld's distinctions supplemented in three ways. First, by separating the goods involved in a transaction from the title to the goods. This is a more recent development in economic theory than Hohfeld's days: we now talk about economics as the exchange of titles to property, rather than as the mere exchange of actual belongings. Second, by separating transactions that involve barter, money, and credit. The growth in the credit economy has been enormous since Hohfeld wrote his analysis. Third, by including guarantees. Consumer protection has also greatly advanced in the modern economy.

Epic language		Emic language
Driver: Please, sell me a car. Dealer: Yes, I am a car dealer.		Ego: I have a claim that Alter does X. Alter: I have a duty to do X.
Driver: I can choose you or someone else to sell me a car. Dealer: Yes, you don't have to buy a car from me.		Ego: I am at liberty do or not to do X. Alter: I have no claim that Ego does X.
Dealer: If you do buy it from me it will cost you Y dollars. Driver: I want to leave my old car to you as part of the deal. And I will pay you in installments. and give you Z dollars in down payment.		Ego:  I want the title to X for Z money, the barter B, and the credit C. Alter: The title to X is yours in exchange for Z money, the barter B, and the credit C
Driver: I can use the car that you sell me any way I want except recklessly against any other vehicle or person on the road since that would violate the latter's claim to be safe from such attacks. I may drive the car, let someone else drive it. When the credit is paid off I can rent it out for money, sell it, give it away, destroy it. Dealer:  I do not care how you use the car that I sell to you.		Ego: I have the power to dispose of X when the credit is paid off, and as long as I don't violate any rights of others. Alter: I surrender my claims about any disposition of  X.
Driver: What help will you give me if this car does not work as expected? Dealer: We pay for any fabrication faults in the car for three years or 10'000 miles, whichever comes first.		Ego: I have after-the-purchase claims regarding X. Alter: I give the guarantees G.
Driver: I don't want to allow you or anyone else to change these conditions. Dealer: I shall have no possibility to change the ways you use the car that I sell to you.		Ego: I am immune from any attempt by any Alter to change my powers over X. Alter: I have no power to change Ego's conditions for disposing of X.

The above illustrates the hidden background of norms for transferring a conventional property in a correct way. A market in a modern economy is a continuous exchange of properties until they end up with the person or organization that is willing to pay the most. As you see, it is a very intricate process, and there is nothing self-evident in an exchange in a market economy. It is a complex human achievement. Please note that what you actually pay for is the title to the car. With a title come the listed powers to dispose of the property and the mentioned  guarantees and immunities.

In any transaction in a modern market economy it is the money that is central, not the goods. A change in the car dealer's wealth is correctly measured in the accounting system by the money he makes on transactions; it is at best only proximate by the change in his inventory of unsold cars. Speaking strictly, as many economists nowadays do, a market economy is a continuous exchange of titles to goods and entitlements to services until they end up in the power of the highest payer. Price controls by governments, churches, cartels, or mafias do not belong in a market economy.

Free and Planned Economies

The fact that property rights refer to a series of separate functions means that governments can enter restrictions on private property by other means than by expropriating it. For example, it can control the housing market in a city by a series of measures such as rent control, rationing available apartments, taxes on sales of apartments and buildings, requirements to let a welfare agency select residents to prevent discriminations, subsidizing public housing so that construction of apartments by private investors becomes unprofitable. Thus the economy may be politically planned.

The free exchange and enjoyment of property rights is a landmark of capitalism, a free economy. The draining of property rights is commonly promoted in the European movement of social democracy (Adler-Karlsson 1969). It lets the owner keep his name on the title of his property but takes over or restricts some property functions. (In the United States and Canada this political program, strangely enough, is called "liberalism.") It is a pattern separate in degree, not in kind, from communism, which lets the state take over all aspects of property and prohibits all private exercise of the different property functions. Here the economy is totally politically planned.

There are some scientifically established limits to planning which we formalized in the proposition on "The Limit of Knowledge about Others."

The price system in a market can collect information in large and complex systems more efficiently than a centralized bureaucracy can do. This has been the insight and message of Friedrich Hayek and his students.

Needless to say, capitalism, social democracy, and communism are not only different economic systems. They are also political systems that differ fundamentally in their views on the freedom of citizens, the distribution of individual and household resources, and the use of revolutionary violence to transform society.

Economic Rationality

The rational pursuit of wealth can follow many paths including systematic robbery and organized extortion. Two more peaceful and rational avenues are the procedures of profit seeking and rent seeking. Rational profit seeking is the pursuit of long-term gains through continuous economic exchanges (Weber 1923). Rational rent seeking is the pursuit of work-free income guaranteed for long periods (Tullock 1989). The former abounds in the market economy and the latter in the welfare economy.

Market Economy and Profit Seeking

A nascent social and economic order in Scotland and England based on profit seeking was codified by Adam Smith in his work The Wealth of Nations 1776. "The desire to improve our conditions, a desire that comes to us in the womb and never leaves us until we go to the grave" was what Smith saw as the source of economic progress. It gets a chance where "natural freedom" prevails, i.e. where every individual has the right and capacity — without fear of punishment from officials, priests, criminals, or Besserwissers – to do what seems best to him or her in the current situation. Individual interests are realized in a division of labor where anyone can establish his shop without restrictions and enjoy free competition with others.

When everyone thus pursues self-interest, overall wealth and welfare are also promoted. Thus, society need not be held together by commands and threats from the government, as had been thought from Plato to Hobbes. In Smith's view, it can cohere through mutual self-interest. "It is not from the benevolence from the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest" is a much quoted insight in The Wealth of Nations. (We have also already quoted it.) In our terminology we would say that Smith sees the the economy, not as an organization, but as a network. It is not a state or a monopoly that runs – or necessarily grants permissions to others to run – industry and trade. It is a market of free agents and free exchanges.

The core of the market economy is profit seeking by means of a continuous exchange of titles to properties, an exchange that comes to a halt, usually temporary ones, when no one wants to pay more than the current bid for the right to the goods or services offered. This point of balance between demand and supply sets a market price.

Adam Smith's recipe for economic growth is an all-inclusive competitive market with increased division of labor. It leads to an increased specialization of firms, making them large and efficient. Here he made the biggest discovery so far in the social sciences: the division of labor on a market is the cornucopia of mankind. In a society with division of labor and free trade between different practitioners all parties benefit. In the end, even the weaker party in an exchange benefits! This seems so unbelievable that politicians in most societies have set up structures to stop or control the tapping of this horn of plenty.

In the decades up to the last millennium, the Schumpeterian growth by "creative destruction" has been somewhat more used in the United States than in Japan and Europe. In twentieth-century Japan, the corporations were exceptionally reluctant to destroy or to renew by bankruptcy. They rather borrowed money from the banks to avoid it, and the banks became stuck with volumes of "non-performing" business loans. In Europe — particularly in France with its heritage of mercantilism and in Germany with its heritage of corporative hegemony — it has been common to counter creative destruction in the economy with various public systems of subsidies or other protections to industries and agriculture in decline. There are, for example, unemployment benefits that do not require the recipient to abandon his or her more or less obsolete occupation for a career in a new field or a new place. 

Weber’s twentieth-century version of the market economy is "rational capitalism" (Weber 1923). It consists of firms (i.e. organizations) that operate as units in markets with many buyers and sellers, and themselves are traded on a stock market. Capitalism, he says, exists when most, not just some, everyday needs of the population are covered by products and services from such firms. The factors of production (land, buildings, machinery, technologies, input goods, inventions, financial capital, raw materials, labor and finished products) are controlled by entrepreneurs in rational capitalism. The art of entrepreneurship lies in utilizing one's access to such factors of production, not to satisfy the personal lust for power, avarice, or private desires, but to gain a lasting rise in value of the firm.

Rational capitalism presupposes that all business events are entered in an accounting system in which data are registered, processed, calculated, and reported to facilitate business decisions. This enables firms to systematically work to retain or improve profits (according to the operating statement) for every business period, and to attain assets that exceed their liabilities (according to the balance sheet) at the end of each accounting period. Rational capitalism, in short, is the pursuit of good accounts for a firm.

To pursue good accounts efficiently, the capitalist management should be free to hire and fire workers, to divide the work between them, and alone command them in the work place. To see workers in such machine-like ways obviously creates conflicts with their lifecycles, and cannot be sustained (see Chapter 30). In his days Weber dismissed this rather lightly as a conflict between formal and substantive rationality. Actually, it is a further illustration of Weber's discovery of the severe conflicts in our everyday life and our institutions that are caused by Western rationalism.

Profit seeking may be rational from the point of the total economy but not necessarily from the point of the individual. To be sure, the market economy produces great wealth. But it is a “wealth of nations,” not necessarily the wealth of any individual. It carries no guarantee against a relative individual poverty or misfortune.

Welfare Economy and Rent Seeking

The guarantees against poverty and any drop in riches are found in rent seeking. The workings of this phenomenon were observed and analyzed by the liberal economist Knut Wicksell in the early decades of the twentieth century. He called the Swedish pension reform of 1913, “rent hysteria,” a choice of words indicating that he was opposed to the reform. This very original version of Social Security payments for old age was delivered in roughly equal amounts by the state to all elderly Swedes regardless of their needs, whether they had been employed or not, and regardless of how much they had paid in taxes.

The reform was originally conceived as a copy of Bismarck's German welfare program for the first big generation of industrial workers, a generation with a rural background who no longer had a farm to retire to in old age. The industrial employers of the period had a routine for paying wages but no routines for paying pensions. They argued that the state ought to run a pension scheme for industrial workers as it did for civil servants. The farmers then wanted the same cash pensions as the factory workers. The universal features of public welfare in Sweden were thus born by the consensus of joint rent seeking of workers, employers, and farmers (Zetterberg & Ljungberg, 1997, Chapter 5).

Rent seeking is a modus vivendi of households. We deal further with this in Chapter 25.

Rent Seeking in Glamorous Social Life

Rent seeking, like Weber’s case of profit seeking, has individual expressions that have little to do with the rationality of the total economy. Peggy Hopkins Joyce (1893-1957) was a gregarious Virginia blond without education and money, married for the first of many times as a teenager. She acquired an insatiable taste for fine clothes, diamonds and a glamorous social life. As a hostess or guest she made most every party a success, and she was a joy in bed. She helped many millionaires separate from their money. She was the model for Gentlemen Prefer Blondes and the hit song Diamonds are a Girl’s Best Friend. The gossip columns of the popular press of the 1920s tabbed her ”gold digger.”

Rational economic welfare has nothing to do with such individual rent seeking.

Stratification and Rewards in the Economy

The economy, more than other realms, can reward its participants with its own product. Those who make money for a firm are rewarded by money, not medals, statues, or publicity.

The Makers of riches, the entrepreneurs, depart from the simple rule that in the economy you are simply rewarded by money. This has made them mysterious to most politicians and academics, even to academic economists. A first key to the understanding of entrepreneurs is the fact that the economic reward system in most countries allows an entrepreneur to attach his name to his enterprise. Local streets display stores and workshops with names of the owners in highly visible signs. And in the streets of the economic capitals you can see corporate headquarters with the family names of the founders, e.g., the Rothschild Bank, the Ford Motor Company, the Krupp Works, E. I. du Pont de Nemours and Company. In the use of such nomenclature, the rewards in the economy are similar to those in art and science where your name or signature also may be attached to your achievement. Their sense of achievement and its visible aspects are important to them. For many, good yearly accounts for their firms means as much (or more) as the amount in their personal bank accounts.

Although numerical scores are available for the economic stratification of riches, the economic reward system contains other units, more visible ones to the public than the bank accounts. The signs of economic position and success that are honored by the larger community in a capitalist economy are based on slacker scales. As Veblen (1899) had elaborated, they may consist of conspicuous goods and services, number of residences (rated as to size and location), number of servants and/or labor-saving devices in the household, annual charity contributions, and so on. Generally speaking, a person's wealth was proven to outsiders by his or her conspicuous consumption.

The reward pattern in the economy is solidified by a series of auxiliary social prescriptions; for example, if a rich man does not show a normal amount of the display of wealth and its obligations he may be denounced as a miser. If a visitor to the successful does not choose to notice or appreciate displayed goods and services in the rich man's home, he may be seen as ungrateful.

In many instances there is a certain self-generation — success by virtue of success — in the reward system of the economic realm, the so called Matthew effect. For example, the economically successful individual may become a creditor and investor, receiving additional income in the form of interest or dividends and perhaps homage from those who may want to borrow money from him.

Also with monetary rewards added, the non-economic realms retain their systems of honor and respect. At the turn of the century, members of the non-economic elites are usually addressed with their title as Doctor, Judge, Warden, MP, Reverend, et cetera. In business you are simply Mr. or Ms. and your formal reward is money and money alone.

Providing Precious Money

Tokens to stabilize economic evaluations were invented to facilitate an exchange of properties. Coins from about 6000 BC, stamped with a lion, have been found in Lydia, the present western Turkey. Coins are standardized pieces of a precious metal that trade at the value of that metal. When in olden times, household were no longer self-sufficient, they first traded for their wants in kind: exchanging cattle for cooking utensils, brides, or whatever that could be used in barters. There was an obvious advantage to using coins in such exchanges, and coins became essential to households. 

With coinage, most everything — tools, produce, cattle, and slaves — could begin to receive generally known prices. Augustus put his picture, retouched to be a symbol of benevolent power, on Roman coins. This practice was how a sovereign power guaranteed to the users the weight and purity of coins. However, subsequent Roman emperors replaced increasing parts of the base metal in the coins with cheaper metals, thus "debasing" the currency, causing a general increase in prices, i.e. inflation in which too many tokens chased available products and services.

Inflation also occurred when the supply of gold increased. There was a scarcity of money in much of 14th and early 15th century Europe, driven by a decline in gold and silver production and a chronic deficit in European trade with the Levant. The Spaniards of the era who conquered and colonized South America had one overriding mission: to bring home gold. The scarcity reversed into its opposite. Gold and gold coins flooded Spain and Europe. This was a largely illusory wealth due to the resulting inflation. In hindsight, this could probably have been avoided if the golden capital had been invested in productive pursuits in agriculture and manufacturing instead of in glamorous lifestyles as favored by the Spaniards. But the idea of productive investments was beyond the horizon of the economists of the day. They advised the kings that gold should be hoarded in state coffers. This mercantilism is not the only false theory that economists have brought to the world.

Providing Paper and Fiat Money

In the Middle Ages, Venice came to function as the principal bullion market for all Europe and the Mediterranean. Zecca, the mint of Venice, produced in successive periods the Penny, the Grosso, the Ducat, and the Soldino.

Paper instruments as tokens for coins of precious metals first developed in Venice and Genoa to finance loans to the state. Eventually foreign states, not just royal personalities and households, could become borrowers. Loans to states could be guaranteed by promising the lender a share of some tax. Special banks emerged to provide these loans and other banks came into being to manage these public debts; the latter we now call central banks.

For merchants, temporary tokens of coins in the from of financial instruments on paper also developed in Genoa and Venice. It could begin with something as simple as the arrival of German merchants to the Venice bullion market with unminted gold from their mines. They got negotiable receipts — we would call them bills or checks — from the Zecca. While waiting for the coins to be delivered they could, if necessary, use these receipts for their expenses and purchases in the city. In 1528, the mint in Venice broadened its assistance to private individuals and firms and began to pay market rates of interest on specie deposits, the so-called depositi in Zecca, a service to manage private capital.

Venice and Genoa succumbed in political strife and wars. The rest of the development of modern finance is located in Amsterdam, London, Philadelphia, and New York. For governments, raising money via bond markets became a form of deferred taxation to finance wars and infrastructures. For example, the young state of Pennsylvania raised money on the Amsterdam bourse to build canals. States need money most when they go to war. Wars have accelerated the buildup of the system for handling national debts.

In February 1797 war loomed between England and France. A frigate from the French fleet off Ireland landed a small number of soldiers at Fishguard in Pembrokeshire. The incident is often called "the last invasion of Britain." The alarming news travelled throughout the country. People wanted the safety of silver and gold coins hands-on, and not only as a promise on paper bank notes that, on demand, they could be exchanged for coins. An impulsive run on the country's banks occurred.

The reserves in the country banks and of the Bank of England quickly run down. Bank of England asked and got permission to suspend cash payments with coins. After February 26, the Bank would exchange only paper for paper. Paper notes of less than £5 in value, which previously had been prohibited was now printed en masse. The promise to pay in coins was replaced by a promise, or rather an unproven assertion, that the new notes were worth £1 and £2 and could be used as tender just as the old coins. This kind of monetary instrument is nowadays called "fiat money" in technical vocabulary.

To the surprise of the British bankers, the new money was accepted by the public and by merchants without any serious protests. Paper money in small denominations, not backed by real precious metals, functioned in the markets! Not until 1821 was the exchange to silver and gold coins reintroduced. However, the habit of suspending gold standards at times of war continued. A suspension was also a common prerequisite for other big expenses such as taxing the economies of the Twentieth Century for the creation of state-run welfare, rather than using communitarian or market-based welfare measures. On balance, however, the gold standard meant that national economic realms were immune from large-scale political manipulations of the money supply, an essential requirement of a many-splendored society whose societal realms cherish their independence.

The growth of wealth in the 19th and 20th centuries is the greatest story never told in full to the rank and file of mankind. They hear more about relative poverty than about absolute wealth. The expansion of wealth was not matched by an expansion of the production of gold. An increased role for paper money was inevitable. Country after country left the gold standard. The United States kept the gold standard into the 1970s. With the US still on the gold standard it became self-evident for governments to have US dollars in their treasuries. The triggering event for Washington to leave the gold standard was a debt of about 3 billion dollars to France that had helped the financing of the Vietnam War. In August 1971 the US government received a request that this loan be repaid in gold. Afraid that other nations would follow the French example,  The Treasury did not see fit to dispense with so much gold from Fort Knox at that point in time. President Nixon immediately took the country off the gold standard.

The United States remained, however, the biggest and most stable economy in the world. Its market for Treasury bills was larger and more liquid than the markets of other government securities, including Bunds in Frankfurt and Guilds in London. The United States Treasury continued to serve as the world's mattress in troubled times. With this in flow of borrowed money, the country could develop a dependency on imported oil, conduct limited but expensive wars, and develop affordable houses to less moneyed households, all without raising taxes. In the first decade of the twenty-first century, the latter involved a selling of toxic derivative securities by government chartered mortgage corporations to banks and money managers not only in the United States but in Europe and Asia and to other takers. This swindle contributed to a world-wide economic depression. It added a very concrete grievance to the anti-Americanism in the world that otherwise was mostly sour grapes and defensive bilge.    

TECH  The fiat money took new shapes in credit cards ("plastic money,") and in electronically controlled accounts ("digital money"). The central banks learned to add (or subtract) to the total money supply by pressing the keys of a computer connected to the banking system; no need to start printing presses. In increasing numbers ordinary consumers also learned to press their computer keys, link up with their bank accounts via Internet, and do their transactions electronically.

Producing Wealth by Manufacturing

History shows many ways of building and handling wealth. We will review only two common ways that differ the most: producing riches by manufacturing and producing riches by finance.

Industrial Revolutions

The production of goods is intimately connected with technology.

An industrial revolution is a large-scale combination of a new technology with new social arrangements. Starting in the late eighteenth century and culminating in the nineteenth one, Europe’s first industrial revolution used the technology of the steam engine and the social organization of the factory. It gave us transport by rail and steamers.

A second industrial revolution began at the end of the nineteenth century and culminating in the twentieth one when combustion engines and electric engines reshaped the factories. The combustion and jet engines later opened for transportation by trucks and cars and eventually airplanes. With electric start motors automobiles could readily be used without a chauffeur's cranking the motor to a start. A mass market opened that included both men and women. Electric devices reshaped not only factory work but also offices and households and everyday living.

After World War II it was thought that the next technological revolution would be called "the atomic age." It was heralded by a big monument in Brussels. One kilogram coal produces energy amounting to 3kWh while one kilo uranium gives 50 000 kWh, that is 16 700 times as much. But the technology to harness this huge energy did not integrate well with existing technologies. Atomic energy did not lead to a new industrial revolution, at least not in its first 60 years.

Instead, the third micro-electronic industrial revolution began at the end of the twentieth century with the digitalization of all kinds of communication, print, music, pictures. Products and packages receive identities in bar codes and animals receive digital identities in chips; anything living can get a record of its unique variation from the DNA of the species. Most importantly, this revolution, unlike the previous two, gets at the core of civilized living, the use of communication by symbols.

Creative Destruction

The shifts in technologies in the three industrial revolutions have produced much wealth. This cannot be summarized in any smooth macro-economic law of equilibrium. In the spirit of Joseph Schumpeter (1942) we must rather focus on the role of entrepreneurs who take hold of the new and destroy the old. The entry of entrepreneurs with new technology is the force that has sustained long-term economic growth. In the first version of his theory, the creative roles of personal efforts by entrepreneurs were seen as critical. Later Schumpeter gave more credit to departments of research and development in big companies and to their innovative marketing departments.

The "creative destruction" that entrepreneurs may cause can be quite dramatic, particularly when the old technology has been in the hands of efficient companies that have acquired a degree of monopoly in the market. Labor unions usually favor the old technology since transformations includes closing factories and unemployment. Strikes, at times with violence, easily became the order of many days during a change-over. The more sophisticated labor economists in Sweden, Rudolf Meidner and Gösta Rehn, took an opposite view and proposed more civilized measures. To achieve as high wages for workers as possible the labor movement should not accommodate to the factories of old technologies but rather maintain a high wage pressure there. This so-called "Swedish wage model" is worth a moment of consideration.

Technological Change and a Wage Model

In 1951 a book by the German-born economist Rudolf Meidner entitled Fackföreningsrörelsen och den fulla sysselsättningen ("The Labor Movement and Full Employment") was presented to a Swedish labor congress. Its core principle is that all jobs, regardless of their line of work, that are the same shall have the same pay in all firms at all places of work throughout the country. This departure from market wages Meidner called "a wage policy of solidarity." Thus differences in wages would minimize between large and small, rich and poor employers, between city and country, between young and old employees, and, what was later emphasized much more than in 1951, between men and women. The less profitable firms would pay the same wages as more profitable ones. This would force out of business firms with old technologies along with those operating in declining markets, as well as firms with inappropriate organization, and/or weak leadership. Workers would then be free, particularly in good times, to move to the more profitable enterprises with new technology and modern organization and leadership of production and capacity to pay high wages.

This policy would maintain a high level of wages in a country, a central union goal. It required generous unemployment compensations between jobs and an active public policy of helping and training people to take new jobs, subsidizing if need be their moves to other towns where they could get jobs in new or expanding firms able to pay good wages. Around these ideas economists from the blue-collar and white-collar unions and the central patronage association could unite. The complaints from firms with marginal profit levels were not heeded. Complaints arose also among some unions (e.g. the miners) that the very rich firms did not have to pay higher wages than others. They were loud at times and often underlined by communists, but on balance the system was accepted. Sweden could embark on long-term big structural and technological changes without as much labor strife as in most other European countries.

A by-product of the model was that the government of Sweden, unlike its colleagues on the European continent, could stay out of wage negotiation in the private sector, a feat cheered by us who believe in a the aspect of the many-splendored society to keep societal realms out one another' hair. This was a silver lining in a society that otherwise suffers from a severe hegemony by the body politic over all other societal realms. Over time technologies and industrial organization became more complex, and the Swedes found it more difficult to tell which jobs were "the same" and thus deserving the same wage. Some locally set individual variations in wages became accepted, but the rules on seniority, working hours, vacations, pensions, and working environment could remain common throughout the entire county.

The silver lining was removed by a prime minister named Olof Palme. In a period with poor standing in the electorate for his social democratic government and a tight budget that did not allow the usual additional welfare measures, he decided to throw the power of the state behind the unions. They received more favorable rules about hiring and firing and about industrial conflicts, rules that they could not have achieved by negotiations with the employers. This legislation cost the government nothing in the budget. It damaged, beyond repair for decades, a memorable, splendored feature of Swedish society, a fair and rational labor market without government dictates.

Development Blocks  TECH

A new major technology such as the steam, combustion, or electrical engines in the past or microprocessors in the present does not automatically produce high economic growth. Nor is competition enough to move it into dominance, as classical economics would have it. A new technology wins its economic successes by combining, not competing, with complementary technologies into a growing manufacturing cluster. In order to take off, the auto industry needed not only combustion technology but steel mills and its complementary technique of buckling metal sheets. To develop a comfortable product it had to use rubber and the know-how of blowing air into tires. To make the process of starting a car easier for the consumer a start engine had to be added from electric technology and a battery from chemical technology. The new technology of covering roads by asphalt rather than stones or gravel came in handy. Thus, for the automobile, entrepreneurs could piece together "a development block" (a term coined by Erik Dahmén 1950) that included also services from investors. Such blocks often form a geographic concentration such as the first auto industry block in Michigan/Ohio.

The typical forms of social organization in a development block is that of what we have called "netorgs." Competition and cooperation take place in networks of organizations. The success of development blocks is thus predictable from our Proposition in Chapter 7 on The Netorg System of Realm Expansion.

When a major new technology such as the microchips is born there is much excitement. At the end of the Twentieth century there was no end to the great aspirations that came with the arrival of the network technology of the Internet. (See John Perry Barlow's declaration cited in Chapter 5.) Silicon Valley, the foremost development block around the new technology, attracted overinvestment. But the potential of a new technology cannot be put to full use until the complementary contributions from established technologies have been developed. An IT boom and bust occurred at the turn of the century before the new technology had found its huge number of applications though complementary technologies ranging from sorting both packages and bank transactions to recording and distributing both music and mail. It is in this later and more mature phase the new technology makes its biggest contribution to economic growth. For historians and theorists of business cycles it may be more useful to pay more attention to the cycle of development blocks than to the first breakthrough of a new technology.

In a market economy, new technologies do not come about by political decisions. No parliament decides to introduce automobiles or the personal computer in a country. But politicians may oppose new technologies. After the nuclear catastrophe in Chernobyl, the Swedish Social Democratic government introduced a law prohibiting, not only planning for new nuclear energy, but any research into the application of nuclear energy. This was an infringement on the autonomy of science. The universities reduced or closed their nuclear laboratories and training programs. The country's nuclear industry, one of the few in Europe, was sold to Westinghouse in the United States. The nuclear energy plants, however, were to run their technological life, perhaps some 40 years. To recruit top engineers under these conditions was difficult. Far from promoting safety, there are reasons to believe that safety standards and maintenance deteriorated due to the clumsy political meddling with the autonomy of the realm of science. More often than not democratic politicians restrain rather than prohibit technologies. It is telling that at the millennium more of the new production details in a car were due to government regulations than to new technology. In the opinion climate at the time of this writing it is particularly common among politicians to restrain technology in the name of reducing global warming. The latter is perceived as a doomsday threat and a good opportunity to do what politicians are good at: to tax and to regulate.

The track record of big government to pick new technologies for public investments suffers from the unfamiliarity of politicians with both entrepreneurs and development blocks. To prevent misplacements of investment capital, politicians with business ambitions must realize that the economy is a different world from politics and administration and has rules and conditions of its own. Politicians must rely on middlemen, Providers and Procurers, who can see these rules and conditions without partisan spectacles or realm biases. This is a hard task for politicians who have been used to recommending lucrative consulting jobs or assignments to cronies.

The significance of development blocks is often omitted in the study of economics. This may explain why non-economists such as investors in new technology compete well with professional economists. The mixed track record of big banks in choosing investments in new technologies is also due to a nearly universal lack of understanding by Keepers (bankers) of the importance of Creators (entrepreneurs). The small European entrepreneurs with new technologies have often a better chance of borrowing money from one another than from banks. The United States has a better system for the supply of venture capital.

Producing Wealth by Finance

In several advanced countries manufacturing and the sale of manufactured goods is no longer the main highway to wealth. Purely financial transactions dominate the international flow of money; payments for imported manufactured goods and commodities come in a poor second.

Finance as a source of riches is the process of making money by means of money. It includes traditional organizations such as banks and insurance companies. A modern bank is much more than an institution that takes in, i.e. borrows, savings from the public at low rates of interest an lends it to others at higher rates. Transactions other than this "interest gap" usually account for the lion's share of modern bank profits. Using the labels in Figure 20.2 we may say that bankers are no longer mere Keepers of money. They act as Brokers for numerous financial services. Likewise, a modern insurance company is more than an insurer of households, factories, and ships. Most anything can be insured, including your health, bank account, and the bonds that depend on mortgage payments. International networks of reinsurers spread the risks. The new financiers are true Makers, i.e., creators, innovators, and entrepreneurs in wealth, making money by money. They not only trade for their institution's account on financial markets. They have invented new types of monetary assets, not all of them sound ones.

In the first decade of the new millennium in the United States, financial services grew to represent more than 20 percent of the gross domestic product, compared with 13 percent for manufacturing. Before the crash in 2008, bundles of consumer loans and home mortgages packaged as securities were the biggest U.S. export business. Between 2001 and 2007 a total of $27 trillion of these securities were exported, i.e. sold to financial institutions in Europe, Asia, Australia, and Africa. Practically all were stamped "investment grade" by rating agencies, and the salesmen probably hinted that this meant that they were "good as gold." To buy them back would have required all of the gross national product of the United States during two years. (Virtually all early issues were redeemed in good order.) When the cash value of these securities became uncertain, the many banks and other financial institutions on all continents that had bought them suddenly became suspected of approaching insolvency; each one knew their own situation and suspected that neighboring ones had the same or worse problem.

In the new ballpark of finance, bankers and insurers are a minority. In the majority are the managers of pension funds, private investment funds, endowments, and charities. Here are also special companies that handle mortgages that borrow money at low rate of interest, provide mortgages for households and firms at higher rates of interest, package these mortgages as bonds for resale, and use the proceeds for further mortgages. Here are stock exchanges, currency traders, and bond dealers. Here are the credit card companies. Hedge funds can deal in anything expressed in money, and so does the whole world of finance. The successes of these financial services has lead to the customary circle of capitalism: over-establishment in good times followed by bankruptcies in bad times.

The new world of finance has also celebrated a bridgehead to conquer the old world of manufacturing goods and producing services. It is called "private equity." With its risk prone capital private equity buys industries, restructures them, improves their efficiency so that they can be sold off within ten or so years. This process may involve paying out parts of the working capital of the acquired firms (that admittedly have often been sleepy) to the new owners. It is replaced with loans from the market. This gives private equity more working capital for new forays of acquisitions. The management of the acquired company gets a new but acceptable pressure to perform better, so that that the interests on its now borrowed capital can be paid.

Any combination of economic values, for example mortgages, can be combined and packed as a "derivative" and sold as a bond. There is nothing intrinsically sinister in this; it is a rational device to spread risks, particularly in areas where some mortgages have been issued to persons with poor credit rating. The initial package may travel as collateral and/or sales object between different financial firms to end up in an investment bank. The investment bank raises its money for this purchase by selling certificates of derivatives to ordinary banks with offices on Main Street in any country in the world. They can offer these at various rate of interest depending of the level of risk. For banks to accept them as part of their capital base, the certificates must be stamped, not like Roman coins by the image of an Emperor, but by a rating agency such as Moody's or Standard and Poor as "investment grade," popularly interpreted as "good as gold." An insurance company may furthermore insure the bonds against default. Now the risks have really been spread on many hands. Many hands have also a claim on a part of the income from the original mortgage.

But the transparency of the first generation of these financial assets has been much reduced when it changed hands to new generations of owners. The risk of defaults at the first stage of this chain was poorly understood. When salesmen from American investment banks turned up to place a certificate in a regional or foreign bank, neither they nor the buyer seem fully aware of all the intricacies in the history and buildup of the investment product that is to be added to the capital of the buying bank. Needless to say the salesmen, like everyone else in this chain, were rewarded by high bonuses. Some packing and certifying actions of the first generation of derivatives may well belong in the right hand part of the semiotic square of wealth, that is, among swindles. 

The market in the United States for derivatives, particularly those involving mortgages, grew significantly in the new century. The commitments involved in the loan transaction of all in-between instances in these chains also grew in numbers. The title documents of these financial assets abound with Saussarian symbols, garlands of words referring to one another rather than to something concrete. Moreover, derivatives transactions were struck privately. The market was unregulated, with no central exchange where prices and volumes were disclosed. This chaotic situation with financial instruments of poor transparency was one of the hall marks of the worldwide financial crisis of 2008. More on this crisis later.

Creative financial processes can be used, not only to capitalist ends but also to socialist ends. Social Democracy has learned to use a high taxation of what belongs to the owners on the balance sheets of firms, and give borrowed capital in firms breaks, for example in the form of a full tax deduction of interests. It may add the use high individual or household wealth taxes to further reduce private capital, making firms dependent on sovereign funds (run by states) or wage-earner funds (run by labor unions). When such measures are combined with mandatory representation by governments and unions on corporate boards, "capitalism without capitalists" is close at hand — without having to resort to much old-style nationalization. At the pinnacle of their power, Sweden's Social Democrats tried to accomplish this. They were met with local resistance and an opinion climate influenced by Margaret Thatcher and Ronald Reagan. In a Europeanized and globalized environment their policies for the economy were not strikingly forward-looking. Much private capital and a couple of the most successful big firms escaped the socialist designs by moving abroad.

Cycles, Bubbles, and Panics

Many exchanges in a market involve delays between production and delivery. This causes booms and busts. A classic example is the so called "hog cycle." Farmers who produce pork must make production decisions before they know what price they will get on the market. About 10 months elapses between breeding a sow and the slaughter of her offspring. Since a hog breeder may not know the decisions made by other producers, cumulative overreactions to very good times as well as very bad times have resulted in a cyclical pattern of production and prices. Agricultural economists show that the full cycle of the pork market takes four years:

• First year: In this good year prices are above production costs and the farmers increase production. Keeping more gilts on the farm for breeding brings less pork to the market. Prices go even higher.

• Second year: The increased pork brought to the market from the now larger herd of sows brings prices to a fall.

• Third year: Oversupply in the market is now apparent; prices fall below all costs of production. Many producers decide to reduce their herds. Fewer gilts are retained and more sows are sold, which causes an increased amount of pork to go to the market for even lower prices.

• Fourth year: Production declines and prices increase to the break-even point or better. A new cycle can start.

This kind of boom and bust for agricultural products is used as justification for the price control that is practiced in some farming countries. We find similar cycles in the markets for all kinds of fashionable goods and for all economic asset classes. Typical booms and busts mark the housing market. Again a root problem is that the builder of a housing project has his costs long before he knows the selling prices of the finished buildings. Also the customers in the housing market easily get trapped in the idea the prices of today are not the prices of tomorrow.

The Stock Market

The fact that firms operating on markets also put themselves on a market is an ultimate crown of the market economy. The stock market takes funds from owners of capital who do not immediately have use for the money and puts it into firms that lack the cash to realize their production ideas. The business plans, conditions and market prospects carry different levels of risks for different firms. By spreading the stocks between firms listed on the stock markets the investor tries to achieve the risk he is willing to bear. In all, allocation of capital available for investments comes into the hands of those the firms believed to have the best chances of success.

By means of the stock market, capital is allotted by decisions inside the societal realm of the economy, and no decisions by tribal chiefs, priests, moralists, politicians, or military strongmen are needed. Without a stock market the realm of the economy would not be independent of other societal realms. A politically planned economy would be the nearest available alternative. A stock market is thus one of the several cornerstones of a liberal and many-splendored society.

At the same time, stock markets expose all listed firms to the booms and busts that are inherited in markets. A bust affects not only investors but employees, distributors, and customers of these firms and, in severe cases, the effects may spread to the general public.

A first scientific understanding of the nature of the flow of communication on a stock market was provided by Vilfredo Pareto, a brilliant Italian social scientist who had started out as a political economist and who contributed a great deal to economic theory. He found economics to be too limited a field to help in understanding certain “irrational” problems, among them, those that appeared in politics. In order to be rational about the irrational, he turned to sociology. He used sociology to construct typologies and theories about the spirit of the times. He used them also in interpreting movements of the stock market. In a paper from 1901 he wrote about the importance of the climate of opinion on the Stock Exchange.

Whereas during the upward trend every argument advanced in order to demonstrate that an enterprise will produce money is received with favor, the same arguments will be absolutely rejected during the downward trend... A man who during the downward trend refuses to buy certain stocks believes himself to be guided exclusively by reason and does not know that, unconsciously, he yields to the thousand of small impressions which he receives to some degree from the daily economic news. When, later, during the upward trend, he will buy those same stocks, or similar shares offering no reasonably better chance of success, he will again think that he is allowing only the dictates of reason, and will remain unaware of the fact that his transition from distrust to trust depends on sentiments generated by the atmosphere around him (Pareto 1901/19??, pp. 93-94).

What people (such as our farmers) talk about during upturns and downturns of a market is governed by a Proposition on Socially Rewarded Convergence.

As Pareto had noticed, a consensus on the trend emerges rather quickly. Let us begin our study at a point when this happens during an upward trend. We will pursue the likely course of events by drawing upon our knowledge from the reasoning on the edifice of symbols (Book 2) and about motivations fuelled by symbols (Book 3) to understand a full cycle of stock market swings. Let’s pursue this in some detail; it will tell the extent to which social science can explain the course of stock market swings. Probably the same processes will account for bubbles also in other markets.

In meeting face-to-face associates and in absorbing the mass media we know from the Proposition on Selective Scanning that people do not observe everything, but tend to focus, among other things, on the evaluative language in use. In an encounter involving a market this would usually be the price.

Furthermore, the Rules of Emotive and Rational Choice tells us that emotively charged symbols are observed first; in this case it may well be the number that reveals how rich you are, i.e. the current market value of your assets.

4:4.  "The Rules of Emotive and Rational Choice"

(a) In scanning a symbolic environment or part thereof man first reacts to the symbols, if any, that have emotive charges and then to the executive symbols.  (b) In this reaction, negative emotive symbols have greater effect than positive emotive symbols.  (c) If all symbols are roughly equally executive, i.e. emotive meanings are spread evenly or are absent, man exercises rational choice.

The rest of the available information is more or less ignored. A period of continuous upward pricing of an asset sets the focus on the daily scanned price at the expense of other information about the asset.

The combined effect of the two cited propositions is that the traders begin to ignore shifts in the underlying realties and follow only the rising price. This is now unrestrained and is bid higher and higher. The volume of trade in the asset increases. Preoccupation in a rising market with the rising price at the expense of anything else is a defining mark of a so called "bubble."

Continuous increases in the value of an asset boast the evaluation and rank of the owner in his social encounters. This adds to his self-evaluation. His personality begins to change. He “re-edits himself” to something grander according to the Proposition on Development of Selves.

For little effort and a small initial commitment of money the investor reaps big rewards. The Proposition on Emotive Sense of Justice gives the investor a sense of exuberance. At this point asset owners tend to spend more on personal and family consumption.

The process in the Proposition on Rank Equilibration in Status-sets begins to work to equalize their ranks of investor and consumer, making the level of consumption more commensurate with the level of the brokerage account. Thus we get extravagance in spending during the rise of the bubble. If we deal with a large bubble this increase in consumption shows up in the statistics for the total economy and spills over into a period of “good times,” celebrated by most everybody.

Here begins a critical phase of the boom and bust process that everyone – bread earners, businessmen, preachers, social workers, and journalists – should worry about. Politicians in particular ought to worry. But this is the time when they, like everyone else, are apt to think that markets take care of themselves. They share in the exuberance, as suggested by the Socially Rewarded Convergence mentioned above. Everybody’s laments and worries, surely real enough, come when the bubble has burst.

When prices of the bubbling asset reflect evermore the expectation of future gains in prices the equilibrium component in Gary Becker's often cited definition of economics — “the combined assumptions of maximizing behavior, market equilibrium, and stable preferences, used relentlessly and unflinchingly, form the heart of the economic approach” — breaks down. Prices in financial markets no longer reflect the supply and demand in the way they were supposed to do.

Bubbles come and go. As a bubble grows, many investors are apt to say “it is different this time.” A good rule of thumb is to be skeptical of any such talk. During the IT-bubble in the 1990s the financial world was full of talk about "a new economy." It had new indices of success, for example "burn rate," the estimated number of month before new capitalization is needed. To the IT-enthusiasts in the stock market, burn rate became more of a buy signal for a company stock than profit.