A recent article at the Mises Institute got me thinking about the concept of “passive investments.” The article was written by Daniel Moule, and is called “Taxing Capital Leads to Capital Consumption.” Setting aside the general argument Moule is trying to make, I find his concept of “passive investment” to be a possible source of confusion.
One pivotal point Moule makes is expressed by a formula:
[expected gain from capital] + [starting capital] – [taxes]
must be greater than (>)
[interest] + [principal] on an alternative passive investment
Moule states that when this condition is not satisfied, investors flee into passive investments, resulting in a loss of productive capital. (By the way, in the U.S. at least, interest payments on many bonds, bank balances, and certificates of deposit are taxed similarly to capital gains, anyway.) However, this argument makes an assumption about “passive” investments which is not justified: namely, that such investments do not involve the production and/or maintenance of capital.
In fact, there are many passive investments that do involve the production and maintenance of the capital stock. Imagine a bond issued by a very large and secure corporation. Assume the chance of default on the bond is negligible. In such a case, the funds collected from issuing such bonds may very well go toward the production, purchase, or maintenance of the company’s capital stocks.
From the perspective of the bond buyer, the investment is totally passive. However, what the bond buyer is doing is providing his capital, in the form of money, to a company which will convert that money capital to working capital: tools, machines, etc. The company uses the working capital to produce a surplus, and returns the agreed part of the surplus to the bondholder at maturity.
We therefore see that some passive investments are proxies for active investments. By contrast, investing in riskier bonds would be more active, in the sense that the investor should spend more time researching the company in question to determine whether it will remain afloat for the term of the bond. Equities and other more liquid investments demand even more attention by the investor, and further along the same line, direct investment in working capital (for instance, to build a new company) requires even more care and involvement.
The real issue comes from “passive” investments that are not used to build or maintain capital. The obvious example is a bond issued by the state. The interest payments on government bonds are funded by taxation, monetary inflation, the issuance of new bonds, or some combination. These payments, in contrast to corporate bonds, depend on the state’s monopolies on violence and the money supply. The point Moule fails to make clear is that it is these actions: appropriation by violence from producers, and dilution of the money supply by counterfeiting, which discourage the production and maintenance of the capital structure.
Here we come to my specific issue with this part of Moule’s argument: it is not that passive investments are, by definition, destructive to the capital stock. Government bonds are. The real problem is that these government bonds are issued in such huge quantities that they almost completely crowd out other low-risk investment opportunities in the market. Even worse, the fact that there is a gun and a printing press behind these government bonds allows large states like the U.S. to reduce their risks almost to zero. For the investor who only cares about risks and returns, the fact that his government bonds are soaked in blood is irrelevant.