WEBVTT NOTE 6.09. Joint-Stock Companies and the Producers’ Loan Market 1 00:00:00.000 --> 00:00:06.000 9. Joint Stock Companies and the Producers' Loan Market 2 00:00:06.000 --> 00:00:14.000 We are now ready to embark on an analysis of the effect of joint stock companies on the producers' loan market. 3 00:00:14.000 --> 00:00:24.000 Let us take the aforementioned firm with a total capital stock and capital value of 130 ounces and owned by six stockholders. 4 00:00:24.000 --> 00:00:34.000 The firm earns a net income of 5% per year for its owners, and this is the interest rate earned by all the firms in the economy. 5 00:00:34.000 --> 00:00:43.000 We have already seen how the firm expanded its capital by 30 ounces through the sale of new capital stock to F. 6 00:00:43.000 --> 00:00:47.000 Let us see what happens when a productive loan is made. 7 00:00:47.000 --> 00:00:54.040 is made. Suppose that the firm borrows 20 ounces from the producer's loan market for a five-year 8 00:00:54.040 --> 00:01:02.360 period. What has happened? The firm has exchanged a future good, a promise to pay money in the future 9 00:01:02.360 --> 00:01:10.360 for present money. The present money has been supplied by a saver, G. It is clear that G has 10 00:01:10.360 --> 00:01:16.660 has done the saving and is the capitalist in this transaction, while the joint stockholders 11 00:01:16.660 --> 00:01:24.080 A through F are here supplying future goods, and further, it is the stockholders who invest 12 00:01:24.080 --> 00:01:27.500 the new capital in the production system. 13 00:01:27.500 --> 00:01:34.280 On the surface, this seems to be a positive case of the separation of savings and investment. 14 00:01:34.280 --> 00:01:38.180 However, let us look at the transaction further. 15 00:01:38.180 --> 00:01:45.240 G has supplied new capital worth 20 ounces to the firm for a five-year period. 16 00:01:45.240 --> 00:01:52.560 The owners A through F take this new capital and invest it in future goods, that is, factors 17 00:01:52.560 --> 00:01:54.120 of production. 18 00:01:54.120 --> 00:02:01.340 In other words, to the extent of 20 ounces, A through F are intermediary investors of 19 00:02:01.340 --> 00:02:03.800 the savings of the creditors. 20 00:02:03.800 --> 00:02:07.160 What will the rate of interest on this loan be? 21 00:02:07.160 --> 00:02:13.400 It is obvious that this rate of interest in the ERE will be equal to 5%. 22 00:02:13.400 --> 00:02:19.480 That is, it will be purely dependent on the rate of interest return that prevails in the 23 00:02:19.480 --> 00:02:22.620 price spreads of the production structure. 24 00:02:22.620 --> 00:02:25.100 The reason for this should be clear. 25 00:02:25.100 --> 00:02:30.460 We have already seen how the interest rate is determined in the production structure. 26 00:02:30.460 --> 00:02:34.060 We have assumed it to be 5% everywhere. 27 00:02:34.060 --> 00:02:40.020 Now suppose that the firm offers to pay G 3% on the loan. 28 00:02:40.020 --> 00:02:47.780 Clearly G will not lend the firm 20 ounces for a 3% return when he could get 5% as a 29 00:02:47.780 --> 00:02:52.300 stockholder either in the same firm or in any other firm. 30 00:02:52.300 --> 00:03:00.020 On the other hand, the firm is in no position to pay G any more than 5% since its net return 31 00:03:00.020 --> 00:03:04.020 on the investment will be only 5%. 32 00:03:04.020 --> 00:03:11.060 If the maximum that the firm can pay in interest is 5% and the minimum that the creditor can 33 00:03:11.060 --> 00:03:19.500 accept is 5%, it is obvious that the transaction will take place at 5%. 34 00:03:19.500 --> 00:03:26.340 It is clear that in essence, G, the creditor on the prospective loan market, is no different 35 00:03:26.340 --> 00:03:30.220 from F, the man who has invested in stock. 36 00:03:30.220 --> 00:03:36.060 Both have saved money instead of spending it on consumption, and both wish to sell their 37 00:03:36.060 --> 00:03:41.820 saved capital in exchange for future goods and to earn interest. 38 00:03:41.820 --> 00:03:48.940 The time preference schedules of both F and G, as well as of everyone else, are aggregated 39 00:03:48.940 --> 00:03:52.940 on the time market to arrive at the rate of interest. 40 00:03:52.940 --> 00:03:57.480 Both F and G are net savers at the market rate. 41 00:03:57.480 --> 00:04:03.400 The interest rate, then, is determined by the various time preference schedules, and 42 00:04:03.400 --> 00:04:10.440 the final rate is set by the savings schedules on the one hand, and by the demand for present 43 00:04:10.440 --> 00:04:13.480 goods schedules on the other. 44 00:04:13.480 --> 00:04:20.240 The demand schedules consist, and consist only, of the productive demand by laborers 45 00:04:20.240 --> 00:04:26.200 and landowners, and the consumption demand by borrowing consumers. 46 00:04:26.200 --> 00:04:33.480 F and G are both net savers, interested in investing their capital for the highest return. 47 00:04:33.480 --> 00:04:40.560 There is no essential difference between F's method of investing his capital and G's method 48 00:04:40.560 --> 00:04:42.360 of investing his. 49 00:04:42.360 --> 00:04:49.720 The difference between investing in stock and lending money to firms is mainly a technical 50 00:04:49.720 --> 00:04:50.720 one. 51 00:04:50.720 --> 00:04:56.640 The separation between saving and investment that occurs in the latter case is completely 52 00:04:56.640 --> 00:04:58.160 unimportant. 53 00:04:58.160 --> 00:05:05.160 The interest return on investment, as set by total savings and total demands by owners 54 00:05:05.160 --> 00:05:12.480 of factors, completely determines the rate of interest on the producer's loan market, 55 00:05:12.480 --> 00:05:15.840 as well as the rate of earning on stock. 56 00:05:15.840 --> 00:05:22.700 The producer's loan market is totally unimportant from the point of view of fundamental analysis. 57 00:05:22.700 --> 00:05:29.300 It is even useless to try to construct demand and supply schedules for this market since 58 00:05:29.300 --> 00:05:32.540 its price is determined elsewhere. 59 00:05:32.540 --> 00:05:38.880 As Frank Fetter brilliantly stated, contract interest is based on and tends to conform 60 00:05:38.880 --> 00:05:46.680 1.2 Economic Interest, that is, the natural interest price differential between stages. 61 00:05:46.680 --> 00:05:53.160 It is economic interest that we seek to explain logically through the economic nature of the 62 00:05:53.160 --> 00:05:54.920 goods. 63 00:05:54.920 --> 00:06:01.080 Contract interest is a secondary problem, a business and legal problem, as to who shall 64 00:06:01.080 --> 00:06:06.480 have the benefit of the income arising with the possession of the goods. 65 00:06:06.480 --> 00:06:11.040 It is closely connected with the question of ownership. 66 00:06:11.040 --> 00:06:18.720 Whether saved capital is channeled into investments via stocks or via loans is unimportant. 67 00:06:18.720 --> 00:06:22.480 The only difference is in the legal technicalities. 68 00:06:22.480 --> 00:06:28.800 Indeed, even the legal difference between the creditor and the owner is a negligible 69 00:06:28.800 --> 00:06:29.800 one. 70 00:06:29.800 --> 00:06:37.800 The loan has increased the capital value of the assets in the firm from 130 to 150. 71 00:06:37.800 --> 00:06:44.800 The invested 150 pays 5% or 7.5 ounces per year. 72 00:06:44.800 --> 00:06:51.800 Let us examine the situation and see who the actual owners of this capital are. 73 00:06:51.800 --> 00:07:03.800 130 ounces of these assets is represented by owner's capital and 20 by liabilities, that is, by IOUs due to creditors. 74 00:07:03.800 --> 00:07:05.800 But what does this mean? 75 00:07:05.800 --> 00:07:11.800 It means that if, for example, the firm were to liquidate and go out of business, 76 00:07:11.800 --> 00:07:19.800 20 ounces of its assets would be used to pay off the creditors and 130 would go to the legal owners. 77 00:07:19.800 --> 00:07:35.800 It means further that of the 7.5 ounces paid out as net earnings per year, 6.5 ounces go to the legal owners and 1 ounce to the creditors, each being 5% of their saving. 78 00:07:35.800 --> 00:07:45.800 In fact, each group gets 5% on its investment, for are not the creditors just as much investors as the stockholders? 79 00:07:45.800 --> 00:07:57.800 In fact, are not the creditors the owners of 20 ounces worth of the firm's assets, and do they not own the pro-rata earnings of those 20 ounces? 80 00:07:57.800 --> 00:08:03.800 What functions of ownership do the creditors not have as compared to the stockholders? 81 00:08:03.800 --> 00:08:14.800 Even from the legal point of view, the creditors get first claim on the assets of a corporation, and they get paid before the stockholders. 82 00:08:14.800 --> 00:08:19.300 They are, therefore, definitely owners of these assets. 83 00:08:19.300 --> 00:08:26.300 It might be stated that since they are not shareholders, they do not vote on the decisions of the corporation. 84 00:08:26.300 --> 00:08:32.300 But there are many situations in which joint stock companies issue non-voting shares, 85 00:08:32.300 --> 00:08:41.300 the holders of which do not vote on company affairs, even though they receive their pro-rate of value of the earnings. 86 00:08:41.300 --> 00:08:51.800 We must conclude that economically and even in basic law there is no difference between shareholders and productive creditors. 87 00:08:51.800 --> 00:09:00.800 Both are equally suppliers of capital. Both receive interest return as determined on the general time market. 88 00:09:00.800 --> 00:09:05.300 Both own their proportionate share of the company's assets. 89 00:09:05.300 --> 00:09:10.300 The differences between the two are only technical and semantic. 90 00:09:10.300 --> 00:09:29.300 It is true that our discussion has so far applied only to the evenly rotating economy, but we shall see that the real world of uncertainty and entrepreneurship, while complicating matters, does not change the essentials of our analysis. 91 00:09:29.300 --> 00:09:44.300 In recent writings, there has been a growing acknowledgement of the essential identity between shareholders and creditors, in contrast to the old tradition that postulated a sharp cleavage between them. 92 00:09:44.300 --> 00:09:51.300 But it is curious that the new literature interprets the identity in precisely the wrong way. 93 00:09:51.300 --> 00:09:58.300 Instead of treating the creditors like shareholder owners, it treats the shareholders like creditors. 94 00:09:58.300 --> 00:10:04.740 In other words, the correct approach is to consider creditors as actually part owners 95 00:10:04.740 --> 00:10:11.300 of the firm, but the new literature treats stockholders as merely creditors of the firm, 96 00:10:11.300 --> 00:10:17.340 in keeping with the new tradition of picturing the hired managers as its real controllers 97 00:10:17.340 --> 00:10:19.420 and owners. 98 00:10:19.420 --> 00:10:25.660 Managers are depicted as somehow owning the firm and paying out interest to creditors, 99 00:10:25.660 --> 00:10:32.140 as well as dividends to stockholders, just as any factor payment is made, as a grudging 100 00:10:32.140 --> 00:10:34.420 cost of production. 101 00:10:34.420 --> 00:10:40.060 In reality, the managers are only the hired agents of the stockholders, and it is the 102 00:10:40.060 --> 00:10:46.660 latter who decide how much of their earnings to reinvest in the firm and how much to take 103 00:10:46.660 --> 00:10:50.660 out of the firm in the form of dividends. 104 00:10:50.660 --> 00:10:56.620 The commonly made distinction between dividends and retained earnings is not a useful one 105 00:10:56.620 --> 00:11:00.140 for the purposes of economic analysis. 106 00:11:00.140 --> 00:11:03.500 Retained earnings are not necessarily reinvested. 107 00:11:03.500 --> 00:11:10.060 They may be held out of investment in a cash balance and later paid out as dividends. 108 00:11:10.060 --> 00:11:15.000 Dividends, on the other hand, are not necessarily spent on consumption. 109 00:11:15.000 --> 00:11:17.860 They may be invested in some other firm. 110 00:11:17.860 --> 00:11:25.140 Therefore, this distinction is a misleading one. Earnings are either reinvested or they are not, 111 00:11:25.140 --> 00:11:30.020 and all corporate earnings constitute earnings of the individual owners. 112 00:11:31.460 --> 00:11:38.340 Savings may be channeled through intermediaries before entering the actual producer's loan or 113 00:11:38.340 --> 00:11:45.620 the consumer's loan market. Finding a productive investment is one of the tasks of entrepreneurs, 114 00:11:45.620 --> 00:12:04.220 and it is often far more convenient for all concerned when the individual, instead of making up his mind himself on the proper channels of investment, lends or invests his money in other institutions, specially set up to be experts in investment. 115 00:12:04.220 --> 00:12:18.220 These institutions may serve as channels, gathering in the small savings of isolated individuals whose investments by themselves are too small to be worth the cost of finding a market for them. 116 00:12:18.220 --> 00:12:24.220 The institutions then invest the funds knowledgably in larger lump sums. 117 00:12:24.220 --> 00:12:35.220 A typical example is the investment trust, which sells its own stock to individuals and then uses this capital to buy stock of other companies. 118 00:12:35.220 --> 00:12:50.220 In the ERE, the interest that will be earned from individual savings via intermediaries will equal the interest earned from direct investments minus the cost of the intermediary's service. 119 00:12:50.220 --> 00:12:55.180 This price to be determined on the market, just like other prices. 120 00:12:55.180 --> 00:13:03.420 Thus, if the interest rate throughout the market is 5% and the cost of intermediary service is 1%, 121 00:13:03.420 --> 00:13:10.140 then in the ERE, those who channel their savings via the convenient intermediary method 122 00:13:10.140 --> 00:13:15.420 will receive a 4% interest return on the investment of their savings. 123 00:13:15.420 --> 00:13:29.420 We have thus seen the unimportance of the producer's loan market as an independent determining factor in the establishment of the market rate of interest or in the productive system. 124 00:13:29.420 --> 00:13:44.420 In many cases, it is convenient to designate by different terms the rate of interest on contractual loan markets and the rate of interest in the form of earnings on investments as a result of price spreads. 125 00:13:44.420 --> 00:14:08.420 The former we may call the contractual rate of interest, where the interest is fixed at the time of making the contract, and the latter the natural rate of interest, that is, the interest comes naturally via investments in production processes, rather than being officially included in an exchange contract. 126 00:14:08.420 --> 00:14:15.220 The two interest rates will, of course, coincide in the ERE. 127 00:14:15.220 --> 00:14:21.540 Throughout our analysis, we have been making one underlying assumption that might be modified, 128 00:14:21.540 --> 00:14:27.700 that individuals will always try to obtain the highest interest return. 129 00:14:27.700 --> 00:14:35.540 It is on this basis that we have traced the arbitrage actions and eventual uniformities of the ERE. 130 00:14:35.540 --> 00:14:41.540 We have assumed that each investor will try to earn as much as he can from his investment. 131 00:14:41.540 --> 00:14:52.540 This might not always be true, and critics of economics have never tired of reproaching economists for neglecting other than monetary ends. 132 00:14:52.540 --> 00:14:56.540 Economics does not neglect such ends, however. 133 00:14:56.540 --> 00:15:01.540 In fact, praxeological analysis explicitly includes them. 134 00:15:01.540 --> 00:15:17.540 As we have repeatedly pointed out, each individual attempts to maximize his psychic income, and this will translate itself into maximizing his monetary income only if other psychic ends are neutral. 135 00:15:17.540 --> 00:15:23.540 The ease with which economics can accommodate non-monetary ends may readily be seen. 136 00:15:23.540 --> 00:15:28.040 Suppose that the interest rate in the society is five percent. 137 00:15:28.040 --> 00:15:36.040 Suppose, however, that there is a line of production that is distasteful to a large number of people, including investors. 138 00:15:36.040 --> 00:15:41.540 In a society, for example, where the making of arms is held in disfavor, 139 00:15:41.540 --> 00:15:49.540 simple arbitrage would not work to equate returns in the armament industry with those in other industries. 140 00:15:49.540 --> 00:15:55.540 We are not here referring to the displeasure of consumers of arms, which would of course 141 00:15:55.540 --> 00:16:01.380 reflect itself in a lowered demand for the product. We are referring to the particular 142 00:16:01.380 --> 00:16:08.580 displeasure of producers, specifically investors. Because of this psychic dislike, 143 00:16:08.580 --> 00:16:14.900 investors will require a higher return in the armament industry than in other industries. 144 00:16:14.900 --> 00:16:26.400 It is possible, for example, that they might require an interest return of 10% in the armament industry, even though the general rate of interest is 5%. 145 00:16:26.400 --> 00:16:31.200 What factors, then, will have to pay for this increased discount? 146 00:16:31.200 --> 00:16:40.400 We are not overly anticipating the results of our subsequent analysis if we state that the owners of non-specific factors, 147 00:16:40.400 --> 00:16:48.080 that is, those factors which can be employed elsewhere, or strictly, the services of which 148 00:16:48.080 --> 00:16:55.840 can thus be employed, will certainly not accept a lower monetary return in the armament industry 149 00:16:55.840 --> 00:17:02.720 than in the other industries. In the ERE, their prices as determined in this industry 150 00:17:02.720 --> 00:17:09.920 will then be the same as in the other industries. In fact, they might even be higher. If the owners 151 00:17:09.920 --> 00:17:16.180 These share the investors' specific antipathy toward engaging in the armament industry. 152 00:17:16.180 --> 00:17:22.880 The burden of the lower prices at each stage of production, then, falls on the purely specific 153 00:17:22.880 --> 00:17:29.640 factors in the industry, those which must be devoted to this industry if they are to 154 00:17:29.640 --> 00:17:32.600 be in the production system at all. 155 00:17:32.600 --> 00:17:39.080 In the long run of the ERE, these will not be capital goods, since capital goods always 156 00:17:39.080 --> 00:17:46.080 These need to be reproduced, and the equivalent resources can gradually or rapidly leave the 157 00:17:46.080 --> 00:17:52.680 industry, depending in each case on the durability of the capital good and the length of the 158 00:17:52.680 --> 00:17:55.040 process of its production. 159 00:17:55.040 --> 00:18:01.280 The specific factor may be labor, but this is not empirically likely, since labor is 160 00:18:01.280 --> 00:18:07.800 almost always a non-specific factor that may shift to several occupations. 161 00:18:07.800 --> 00:18:16.200 It is therefore likely to be specific land factors that bear the brunt of the lower return. 162 00:18:16.200 --> 00:18:21.880 The opposite will occur in the case of an industry that most investors specifically are very 163 00:18:21.880 --> 00:18:25.880 eager to engage in for one reason or another. 164 00:18:25.880 --> 00:18:32.160 In that case, they will accept a lower interest return in this production process than in 165 00:18:32.160 --> 00:18:33.160 others. 166 00:18:33.160 --> 00:18:42.160 The force of competition on the market will, once again, keep non-specific factors at the same price from industry to industry, 167 00:18:42.160 --> 00:18:50.160 although the price might be lower if the factor owners were also particularly eager to work in this industry. 168 00:18:50.160 --> 00:19:00.160 The higher prices at the various stages are therefore reaped by the owners of specific factors, generally land factors. 169 00:19:00.160 --> 00:19:06.960 The rate of interest, then, always tends toward equality throughout its various sub-markets 170 00:19:06.960 --> 00:19:13.920 and in its various forms. In the ERE, the rates will be uniformly equal throughout. 171 00:19:14.560 --> 00:19:20.640 This conclusion must be modified, however, to state that the rates of interest will differ 172 00:19:20.640 --> 00:19:27.440 in accordance with a psychic component, either positive or negative, depending on whether there 173 00:19:27.440 --> 00:19:35.960 There is an acute dislike or liking among investors for a particular production process. 174 00:19:35.960 --> 00:19:41.340 Similar psychic components may occur in the consumer's loan market, for example, if there 175 00:19:41.340 --> 00:19:47.000 is a general strong liking or dislike for a certain borrower. 176 00:19:47.000 --> 00:19:53.760 We may say that, in the case of a particular liking, the investors are consuming the enjoyment 177 00:19:53.760 --> 00:20:00.000 of Investing in the Particular Process and Paying the Price of a Lower Return. 178 00:20:00.000 --> 00:20:06.820 In the case of a particular dislike, they are charging more for a particular disutility. 179 00:20:06.820 --> 00:20:12.900 It must be emphasized, however, that these differences in return do not occur if merely 180 00:20:12.900 --> 00:20:20.960 one person particularly likes or dislikes a certain field, but only if there is a significant 181 00:20:20.960 --> 00:20:26.200 aggregate of strong preferences in one direction or another. 182 00:20:26.200 --> 00:20:32.680 This type of consumption, positive or negative, is intertwined in the production process and 183 00:20:32.680 --> 00:20:39.320 occurs directly with production and thus differs from ordinary consumption which occurs at 184 00:20:39.320 --> 00:20:42.320 at the end of the production process.