To increase production, man must form capital. To create it, he must restrict his consumption and transfer his labor for that period from producing immediately satisfying consumers’ goods.
The restriction of consumption is called saving, and the transfer of labor and land to the formation of capital goods is called investment.
The word "investment" is used differently in economics than in finance. In economics, "investment" refers to using resources to produce capital goods. In finance, "investment" means buying any resource or product with the intent to profit, either by using it to produce consumer goods, or by selling the resource or product later, when the price has risen. Thus, a purchase of a gold bar that one hoards until a day when supply and demand have resulted in a price rise that enables it to be sold for profit, would be a financial investment, but would not be an economic investment. This is because gold bar has not been modified in any way to be a good of a lower order than what it was.
Choosing to invest
In every action, men try to obtain the greatest advantage, i.e., to maximize their "psychic revenue" or "psychic income."
Suppose an investor faces the choice to invest his saved money in various projects, with the prospect of earning 10 percent in a year, 8 percent and 6 percent. Other psychic factors being equal, he will tend to invest in that line where he expects the greatest net money return — in this case, the 10 percent line. But what if he has a great dislike for the product offering a 10 percent return, but has a great fondness for the product promising the 8 percent return? The pleasure in producing one product as against the distaste for producing another are consumers’ goods, positive and negative, which the actor has to weigh to decide where to make his investment. He will weigh not simply 10 percent vs. 8 percent, but "10 percent plus a disliked production process and product" vs. "8 percent plus a delightful product." Which alternative he chooses depends on his individual value scale.
Similarly, man as a prospective investor must choose whether to invest at all. Every man must allocate his money resources in three ways: for consumption, investment and in adding to his cash balance. The marginal advantage of making the investment is more money in the future, that he could spend on consumers’ goods. Because of time preference, enjoyment of a given good is always preferred as early as possible. In deciding whether or not to invest, he must balance the additional return against his desire to consume in the present rather than the future. He will decide in accordance with his value scale. Similarly, he must weigh each against the marginal utility of adding to his cash balance.
Mobility of Investment
Capital has a limited convertibility, but the investor is free to invest anywhere. This is manifested in the phenomenon misleadingly called capital flight. Individual investors can go away from investments which they consider unsafe if they are ready to take the loss already discounted by the market. Thus they can protect themselves against anticipated further losses and shift them to people who are less realistic in their appraisal of the future prices of the goods concerned. Capital flight does not withdraw inconvertible capital goods from the lines of their investment. It consists merely in a change of ownership.
Maintenance of capital
A large part of investment must be spent simply to offset wear and tear and obsolescence of the existing capital stock.
In a country such as the United States, with an enormous fixed capital stock built up over the centuries, a great amount of funds must be allocated simply to maintain that stock. According to an estimate, in 2006, gross private domestic investment reached its most recent peak, at $2.33 trillion (in constant 2005 dollars). After remaining almost at this level in 2007, this measure of investment fell substantially during each of the next two years, reaching $1.59 trillion, in 2009. The "private capital consumption allowance" that attempts to measure these maintenance costs, has ranged from $1.29 trillion in 2005 to $1.46 trillion (in constant 2005 dollars) in 2009. Thus, even in the boom year 2006, about 60 percent of gross private domestic investment was required merely to maintain the economy’s productive capacity, leaving just 40 percent, or $889 billion in net private domestic investment, to increase that capacity.
From that level, net private domestic investment plunged during each of the following three years, it fell in 2009 to only $54 billion (in constant 2005 dollars), having declined altogether by 94 percent from its 2006 peak! In 2009 only 3.5 percent of all private investment spending went toward building up the capital stock. Thus, net private investment did not simply fall during the recession; it virtually disappeared - while the maintenance costs kept increasing.
There is a tendency to make a sharp distinction between purely speculative ventures and genuinely sound investment. The distinction is one of degree only. There is no such thing as a nonspeculative investment. In a changing economy action always involves speculation. Investments may be good or bad, but they are always speculative. A radical change in conditions may render bad even investments commonly considered perfectly safe.
A speculator is someone who earns a living trading in futures markets. They are often vilified in public discourse and blamed for increasing prices. However, it is the speculator who assumes great risk, and this exchange helps to maintain inventory; as a result, speculators are benefactors of society.
In short, they buy low when a surplus exists, hold, and then sell when the price increases due to higher consumer demand. The newly introduced product from the speculator will tend to reduce prices again. Meanwhile, producers continue operations, thereby ensuring that enough is available to meet future demand. Without a speculator providing incentives to producers, shortages and rapid price fluctuations can occur. All actors would find it difficult to plan in such an environment, and resources would be frequently misallocated.
- ↑ Murray N. Rothbard. "9. The Formation of Capital", Man, Economy and State, online edition, referenced 2010-02-08.
- ↑ Murray N. Rothbard. "7. Maximizing Income and Allocating Resources", Man, Economy and State, online edition, referenced 2010-02-08.
- ↑ 3.0 3.1 Ludwig von Mises. Chapter 12—The Economics of Violent Intervention in the Market, 8. The Mobility of the Investor, Human Action, online edition, referenced 2010-02-08.
- ↑ Robert Higgs. "The Great Divergence: Private Investment and Government Power in the Present Crisis", The Independent Institute , on Sep 18, 2010. Data taken or derived from the National Economic Accounts prepared by the Commerce Department’s Bureau of Economic Analysis (Tables 1.1.5, 1.1.6, and 5.2.6 - see a list of tables for information. Referenced 2010-09-20.
- ↑ .Reference Walter Block. Chapter 7 - Defending the Undefendable