Saturday, October 4, 2008

Capitalism is easy to understand and interesting

Forget everything you thought you knew about the "definition" of capitalism. Here is an easy to understand explanation of what it really is, as a springboard from my previous post about history.

Capitalism is what you have when an individual or a family grows enough food to meet their own needs to eat, and also grows an extra amount that it sells for cash. That is the definition and origin of capitalism.

The extra amount of food that is grown is called a "surplus." The fact that it is sold for cash is capitalism. For example, if it was swapped for a different type of food, that is called "bartering" and is not capitalism.

Many people define capitalism as being "the law of supply and demand," but that is not true. Supply and demand is the method by which the family sets and obtains a cash price for their surplus.

For example, cars run on gasoline, but a car was not built because someone was looking for a use for gasoline. Thus supply and demand is like gasoline for a car. It is the method by which the car runs. So supply and demand is the method by which the family prices and then settles on cash for their surplus.

For example, suppose that a family grows corn. They grow enough corn to feed themselves, and some extra that they can sell. One year corn is abundant, so they don't get a very high price for their extra corn. But the next year corn is either scarce due to crop failures or in high demand because of extra usages of corn becoming popular, so the family gets a higher price for their surplus corn than they did the year before. That is an example of supply and demand fluctuating from year to year, and thus an example of "low demand" one year followed by "high demand" the next year.

Here is another example. Suppose a family really likes broccoli. They grow enough to meet their own needs to eat, and also some surplus. But when they go to sell their surplus broccoli they find that no one else has a taste for it like they do. They either cannot sell it or they settle for a low price figuring that even a small amount of cash is gravy since their primary reason to grow the broccoli is their own eating habits. That is an example of supply and demand that illustrates a "low demand" situation.

Farmers invented capitalism. It's not a devious tool of evil western bankers. Capitalism was the natural and healthy outcome of human culture, family by family, raising itself up from subsistence farming (that means farming that yields just enough for the family to be able to eat and not starve) to having surplus that it can sell. Capitalism is as natural as rain. Capitalism has nothing to do with greed and exploitation. Capitalism is grassroots; it sprang up on the family by family boundary between "having just enough to live" to "having something extra to sell." So no one "invented" capitalism and it exists everywhere in all cultural systems. What is invented is the methods of obtaining cash (the demand mechanism), gauging interest in the surplus (the supply mechanism) and the reaching of markets where the deals are struck.

Every family should have this original mindset of capitalism if it wants to be healthy, even though people in developed countries are no longer subsistence farmers. There are several reasons for why this is important. One is that you cannot help impoverished people elsewhere in the world if you do not understand and support this form of capitalism. "Surplus being taken to market" is THE way that people are lifted out of poverty. That is why a "handout" mentality fails. Of course you need to supply emergency and subsistence food, medicine and shelter as stop gap measures. But to raise people permanently out of poverty they must be able to provide for their own needs plus generate a surplus for cash.

The second reason it is important that everyone understand and embrace this origination and definition of capitalism is that it is the prudent and balanced way to view things. I don't need to remind people of the current housing market and financial crisis as an example. Again, let's look at the car and gasoline example. Suppose your car breaks down. Do you yell at the gasoline saying "You stupid gasoline! You made me invent the car and now the car doesn't work! It's all your fault!" That is what it is like when ignorant people blame "capitalism" whenever there is a financial problem or shortcoming. It's like blaming gasoline for your even having a car that then gets a flat tire. It's not the gasoline's fault that you need a car or that things break. Likewise it is not capitalism's "fault" when there is a huge scandal, mess, crime or stupid decision making.

I know it is hard to think about capitalism as a family by family "subsistence plus extra for cash" definition because modern society seems to have come so far from that reality. However, it was only forty years ago that this was still being taught in schools and personally experienced by many families in the US. My grandparents, for example, raised their own food to eat and sold the surplus in the farmers' market to obtain cash. So my generation both saw this in practice and heard about it explained in schools. Again, here is my experience. In the summer of 1962 when we were staying with my grandparents, when my mother needed some cash she joined my grandfather and grandmother up the ladder picking cherries which they then took to the farmers' market to sell. Later in school history teachers taught what I put in the previous post about tribes, clans and flock/herd/land owning explaining the transition that all developing people make family by family from "subsistance" to "surplus." Children used to be taught reality and not agenda.

So whenever one gets confused by complicated financial messes of today, it is very helpful to impose whatever you are hearing upon the original measuring stick of capitalism because it helps you to sort through to the essentials very quickly. Here is a quick example, without getting into a lot of detail.

Everyone today has heard the marketing expression "to create a demand" or to "create buzz about a product." Often that is the average person's first "entry" into even thinking about capitalism, and that is unfortunate but inevitable. Original capitalism springs from a recognized human need (the corn example) that prospers enough that the supply crosses the boundary from subsistence to surplus. Thus one family "has" a surplus of what other families "want and can use." The capitalism transaction is a natural outflowing of what people need and want.

In recent decades, however, product is being envisioned and invented whether it is needed and wanted or not, and then peddled to potential buyers. In other words, people are "convinced" that they need a product before the need actually exists. Now, I'm not being all austere and being against luxuries. But I'm helping you think through what is actually capitalism and what is societal quirks and dysfunctions. Any parent out there knows what I am talking about when they think about how marketers constantly "create a need" among their kids. I remember the days before and after "name brands" became de rigeur among kids, such as for expensive sneakers. If you think back to the original model I have explained here of capitalism, you can recognize the difference between the surplus of an "essential commodity" being taken to market (corn, for example) and some product being invented out of an idea factory and then being "marketed" to potential consumers to "create" a need. There is nothing wrong with having a great idea and then convincing lots of people to buy the product except for one thing: society as a whole starts to forget how to distinguish between "essential commodities" and "created products." There then is a cascading series of risks of displaced emphasis and priority with disastrous effects. The diverting of corn from feed to ethanol is a perfect example of this problem. No one thought through the difference between growing a surplus to provide the corn to a new use (ethanol) and cutting into the subsistence use of corn (feeding people and cattle).

This is so essential that I want to make the point a second time. Because I'm sane and a good economist who actually understands humans I made an assumption when I first heard about the push for ethanol development. I assumed that ethanol producers were paying to take farm land that was now idle and putting it to corn growing. In other words, I never dreamed that they were going to extract the corn out of the food and feed subsistence market. To this day I am still boggled that anyone was so irresponsible and stupid as to do that. I assumed that anyone in their right mind was going to first create a surplus of corn in order to put it to this massive scale new usage (ethanol), and not take the corn out of the mouths of humans and animals. So the ethanol disaster is not the fault of "capitalism," it is an example of how people have become totally detached from discerning the reality of distinguishing between subsistence and surplus "supply."

See what I mean? If you always use this model that I have taught you as your baseline of understanding capitalism in general, then you can put yourself on a knowledgeable basis of foundation for discerning opportunities and pitfalls in even complex decisions and transactions. For example, if I had been consulted (ha ha, dream on) when the ethanol idea first came up, I'd have asked "Where will the corn come from?" This is because being real intelligent I know that corn is an essential foodstuff for humans and animals. I would have assumed, I must confess, that the answer would have been the executives whipping out a list of idle farm properties that they would put into production of new corn growing. My jaw would have dropped if I heard them say they were going to "go to the market" for the corn, which means, compete against humans and animals who actually need and eat this product and thus end up making the price of food skyrocket. Then I'd have b-slapped them, so to speak.

The ethanol disaster is an example of how people have 1) forgotten the basic principle of capitalism which is surplus on TOP of subsistence, not biting into subsistence 2) too often created a demand for a product using fallacious lures and assumptions and 3) lack of discernment of all the pros and cons of a given "product" development. I don't want to be cynical but being a realist there is implication number four: these three problems open the door to a small but powerful clique who know full well the disaster they are about to wreck onto people but are in it to pull out the maximum money that they can before "the gig is up." Thus I suspect that some people knew full well that they'd destroy the food prices for the average Joe and Mary but they locked into commodity and other bets to maximize profit when corn prices spiked and did not care at all whether ethanol "succeeded" or not.

I think this capitalism explanation is helpful in getting people on the same page to understanding a lot of the economic problems (and very hidden opportunities) that people are struggling with globally. As always, I hope the young people in particular find this information a truthful beacon and context setting.