Investment Ethics - What is True Capitalism?

Capitalism is the economic engine of the world.  There is no denying that fact.  Of course, there are significant parts of every economy that are part of the ‘state’ and therefore not subject to private investment and management, but the true driving force is capitalism.

Here is my simple description of how capitalism works in its pure form: 

•  An entrepreneur with a dream or idea starts a company
• People invest in the company and become part-owners because they believe that the company will grow, create ‘value’ and become profitable
• People work for the company for wages based on the market value of their labor
• The investors receive some portion of the profits (dividends) based on their share of ownership
• The value of the shares of ownership grow or decline based on the current profitability of the company and the market perception of its future potential for growth.

In an ideal world, that is how capitalism and investment would work.  In theory, our goals as investors should be to encourage the creation of jobs and valuable work output (i.e. value creation) in our society and benefit when those goals are achieved.  If the company does well, then all the investors should benefit.  If it fails, then all should face the consequences.

But investment is often independent of, and even at odds with what I would call the ‘capitalist spirit of creating value’.  Investment is more like gambling.  Most people are perfectly happy to make money regardless of the success or failure of the company in which their investment lies. 

Examples of this are numerous:  the short sellers are the most egregious example.  When short sellers make a profit off the failure of a company, they are not benefiting from any sort of ‘value creation’, which is the whole purpose of capitalism.  On the contrary, they are simply taking money from other people who are not aware of the impending decline of the investment.

Trading in investments like bitcoin is another example.  There are many investments that produce no identifiable value, or dramatically exaggerate value in order to produce a FOMO (fear of missing out) in potential investors. These investments are the equivalent of a casino.  The casino mentality is a ‘get-rich-quick’ mentality, typically at the expense of others who are getting-poor-quick!  And sadly, most people are perfectly happy to obtain money in this fashion.

When there is no value creation – no new products or services created and providing value to the world – the investment game is zero sum.  For every winner there must be a loser.  One can argue that the poor schmucks who lose are themselves to blame for their losses, but this is certainly not an ethical stance.

Perhaps I am being puritanical here. I have never enjoyed gambling and I find no pleasure in ‘winning’ when my winning means that others must lose.  I never buy lottery tickets and Las Vegas is the last place I would choose to go for a vacation!

Interestingly, real estate is also somewhat of a strange investment.  No ‘new’ value is being created in property or housing as these assets age.  In theory, their value should be a constant, adjusted only by inflation.  Yet real estate has been the path to riches for many people simply because of the laws of supply and demand, and the relative scarcity of real estate in desirable locations as populations grow.  In my view, real estate investors are also parasitic, increasing their wealth at the expense of others.  Another case of the haves screwing the have nots.

And finally, to firmly cement my contrarian views, I will condemn the entire financial services industry for its absurdly high salaries and commissions.  How much value they actually create requires a fairly complex analysis that I am not able to conduct.  But if I were a betting man (and clearly I am not!) then I would bet a large part of my wealth that their added value (which is a service) is a tiny fraction of the trillions that they skim off of financial transactions.  One has only to view the list of the world’s wealthiest people to see how many are hedge fund managers, bond traders, investment bankers, venture capitalists, and other types of so-called financial wizards to realize that they have substantially rigged the game in their favor.

Investment is generally a good thing for everyone.  But it is also clear that the wealthier one is, the more one may benefit from investment.  Access to information, often 'insider' in nature, and opportunities to invest in higher yield investment options are available much more frequently to the wealthy.

The world’s capitalist economy is complex and unjust in many ways.  Alas, there is no simple way to fix it.  Revolutionary doctrines and socioeconomic models have been spectacular failures.  So, we keep plodding along with capitalism and try to make it as humane as possible.  But perhaps if people could feel ethically compelled to make investment choices that truly add value to the world rather than simply enrich themselves, then capitalism would improve significantly.