Building Growth And Wealth
The relationship between debt and equity financing is influenced by income taxes. Companies pay taxes on retained earnings and dividends, but not on interest payments. Our approach explores this relationship in greater detail.
The supply of debt is theoretically unlimited, while the source of equity is finite. The demand for debt is limited to the employable population and potential for growth. The finite demand for equity creates a zero-sum market. Central banks rarely print money to buy shares.
We argue that straightforward debt financing of projects is possible in a perfectly competitive market. Competition drives these businesses towards zero profits, but many can grow by increasing employment and salaries. This creates a positive-sum scenario where everyone benefits.
When unique differentiation allows for monopolies or oligopolies, companies can generate profits. This extra net income becomes real company value, and such companies often go public, issuing equity. Investors buy shares, accepting the increased risk and complexity. The fixed amount of recurring income makes this market zero-sum.
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We analyze interest rates from a systemic perspective. The market penalizes rates significantly higher or lower than the actual risk, as such imbalances can trigger defaults. These imbalances also act as government money transfers without corresponding value creation, eventually depleting the funding source.
We assume free markets within a capitalist system. Credit is abundant as long as central bank interest rates are paid. Investment banks ensure rates match risks, forced to compete by deposit regulations aligned with Basel standards. This requires them to invest only in viable business plans.
This debt model favors franchise financing, discouraging excessive competition (e.g., another Taco Bell across the street). Sharing a fixed market encourages debt financing. Traditional economies have recurring revenues, ensuring stability and lower rates.
The debt market is highly liquid. New projects require underwriting banks, employees, and safety measures. The resulting extra profit is minimal due to competition in a free market.
Some markets have distortions like licensing, research requirements, education, or experience barriers. Fewer projects are built compared to demand, leading to oligopolies with prices exceeding costs. The resulting profits yield dividends above risk levels, spurring investment and rapid growth, as seen in technology. Debt fuels growth and wealth creation, exemplified by cloud data centers. The Nasdaq tends to be more profitable than the Dow Jones Industrial Average.
Building something independently can yield returns beyond just the time invested as an employee. In perfect competition, the value may be minimal, with interest payments reducing net income and company valuation.
Monopolies can arise in knowledge-intensive industries. Extra profits are eventually divided as competitors enter with differentiation. Increased competition and reduced differentiation lower prices. Differentiation and unique standards can maintain high prices, as seen with Apple or game consoles. Eventually, market knowledge becomes widespread, increasing supply and lowering prices.
As profits soar, equity prices rise above actual returns, as seen in the diverging valuations of bonds and stocks in the 2010s. Stocks accumulate cash from the system, creating wealth as shareholder value. This naturally addresses excess profits without corresponding value creation.
Sudden stock sell-offs create price elasticity. If retirees or foreign investors demand their money back, share prices can plummet, as in 2022 due to the Russian crisis. This occurs because accumulated wealth didn't build the economy (it was a wealth transfer) and because the debt market diverges from equity. Only part of the interest rate matches risk to build wealth; the rest is a wealth transfer, like government contracts. The debt game is positive-sum; the equity game is zero-sum.
This is caused by overly conservative and orthodox economic systems. The labor market and education systems cannot keep pace with the flow of money. Scarce education leads to thriving companies with knowledge differentiation and limited competition, generating extra profits.
We conclude that a truly free market approach supports rapid growth, aligning knowledge and risks with financing and labor, allowing growth without impacting traditional businesses. Requirements like licensing, Basel standards, or oligopolistic banking distort this growth towards specific industries. Free capital markets are positive-sum but sometimes necessary to ensure essential services.
Licensing and complex education requirements can create oligopolies or monopolies with high profits. Healthy free capital markets would strengthen these companies, matching unique knowledge with cheap central bank debt. Rigid licensing prevents this, leading companies and investors to hoard cash or invest in constrained vehicles like Bitcoin. Wealth building shifts from economic growth to asset accumulation, becoming a zero-sum game.
Lottery winners might choose investments like Bitcoin to preserve their wealth share without risking their one-time gain. Such games are also zero-sum.
When excess wealth re-enters the economy, it can distort risk-rate relationships. Poor timing can hinder funding rounds and cause defaults. A free-market monetary system, with robust education and social welfare, best aligns wealth with value. Such countries can match fluctuating funds with strong business plans executed quickly.
The 2020s have shown that scarce money and tight regulations are artificial tools for education and discipline. Free market systems focus on building the economy instead.