The Ritual of Capitalization
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Fix, Blair Article — Published Version The Ritual of Capitalization Real-World Economics Review Provided in Cooperation with: The Bichler & Nitzan Archives Suggested Citation: Fix, Blair (2021) : The Ritual of Capitalization, Real-World Economics Review, ISSN 1755-9472, World Economics Association, Bristol, Iss. 97, pp. 78-95, https://bnarchives.yorku.ca/707/ This Version is available at: https://hdl.handle.net/10419/242970 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may be saved and copied for your personal and scholarly purposes. You are not to copy documents for public or commercial purposes, to exhibit the documents publicly, to make them publicly available on the internet, or to distribute or otherwise use the documents in public. If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. http://creativecommons.org/licenses/by-nc-nd/4.0/
real-world economics review, issue no. 97 subscribe for free 78 The ritual of capitalization Blair Fix [York University, Toronto, Canada] Copyright: Blair Fix, 2021 You may post comments on this paper at https://rwer.wordpress.com/comments-on-rwer-issue-no-97/ Abstract For more than a century, political economists have sought to understand the nature of capital. The eaiig id i ha hee be ehig ea some productive capacity that underpins capitalized values. This thinking, I argue, is a mistake. Building on Jonathan Nitzan and Shimshon Biche he f caia a e, I age ha caiaiai i a ideology. It is a quantitative ritual for converting earnings into present value. Although the ritual is arbitrary, it gives rise to astonishing empirical regularities, reviewed here. The enigma of finance There is something mysterious about finance. The symbols are arcane. The math is complex. The practitioners are impressively educated. And the stakes are high. All of this gives finance the veneer of higher truth as if quants (quantitative financial analysts) are uncovering a reality not accessible to the e f . I a ee he ae. B he eai i ha hik. When you look at stock-market numbers, they do point to a truth about the world. But it is a truth not about natural law or human nature. It is a truth about human ideology. The reality is that finance is a quantitative belief system. At its center is a universal ritual the ritual of capitalization. It is this ritual that underlies all stock-market numbers. In this essay, I explore the regularities that stem from the ritual of capitalization. They are astonishing in scope a breathtaking consistency to human behavior. They beg the mind to look for some material basis for their existence. But that is a mistake. The reality is that the regularities of capitalization are an artifact of ideas a manifestation of capitalist ideology itself. A regularity from ritual. Giving property a number The ritual of capitalization starts with the institutional act of exclusion namely property. 1 Property, of course, has a deep history that long predates capitalism. I will not wade into this history here. Instead, I will defer to Jean-Jacques Rousea ccic (b acha) eig f e eegece. Property arose when []he fi e h, haig eced a f ad, k i i hi head a hi i ie ad fd ee ie egh beiee hi (Rea, 1992). 1 Here is how Nitzan and Bichler describe the exclusionary act of property: The ia feae f iae ownership is not that it enables those who own, but that it disables those who do not. Technically, anyone can get i ee ee ca ad die aa, gie a de e a f Wae Bffe hae i Bekhie Hahaa. The sole purpose of private ownership is to prevent us from doing so. In this sense, private ownership is wholly and only an institution of exclusion, and institutional eci i a ae f gaied e (Nia & Biche, 2009).
real-world economics review, issue no. 97 subscribe for free 79 Pig a fece ad ehig ad caig i e i e e f caiaiain. But property alone is not enough. Romans had property. So did most feudal kingdoms. But these societies did not have capitalization. To capitalize property, there is a second step. You must mix property with finance. The d fiace eke a ee f awe a sense of other-worldly complexity. But at its heart, finance is simple. It is the act of reducing property to a number a price. Merge property and finance, and you have capitalization. How this merger happened historically is complicated. But le agai edce hi to an apocryphal story. To paraphrase Rousseau: Having enclosed a plot of land, the first capitalist took it into his head to put a number on his property and found people simple enough to believe him. This act of giving property a number, Jonathan Nitzan and Shimshon Bichler (2009) observe, is the central ritual of capitalism. It is the ritual of capitalization ad i ce ih a be. Becae caiaiai i iea j aig be e, a be is as good as the next one. My property could be a 23. It could also be a 1023. In other words, property can have any cceiabe ice. B hich ice i cec? Ee ice acha caiai a be his property, capitalists have agonized e hi ei: ha i he true ae f e? Like so many human-created enigmas, the scientific answer is that the question has no meaning. Deeiig he e ae f e i ike diceig he e ae f he H Tiity. It cannot be de becae hee i bjecie h ce there are only subjective human beliefs. The e ae f he H Tii i haee chch ceg defie i be. The ae hd f caiaiai. The e ae f ety is whatever capitalists define it to be. This arbitrariness is why capitalists need a ritual. If you are going to answer unanswerable questions, there is no better way than through ritual. Think of a ritual as a mystified habit a repetitive behavior that you reify with significance. As an example, take the ritual of gesturing the cross. It is a reified habit that Catholics use to symbolize both their faith in the Holy Trinity, and to remind them of how the Trinity has been defined (the Father, Son, and Holy Spirit). Rituals are surprisingly powerful, especially when ingrained during youth. I will use myself as an example. During my childhood, my family went to a Catholic church, and I attended Catechism (Sunday school) weekly. I learned all the ritua ha ae a f Ma. Afe beig cfied a a Cahic a age 13, however, I stopped going to church. Today I am an atheist who is skeptical of religion. Yet if I hea he d i he ae f he Fahe, S, ad H Sii, I hae he ea-irresistible urge to gesture a cross. That is the power of ritual. Capitalists have invented a similar ritual, but it is not physical. It is mathematical. Faced with the desire k he e ae f hei e, caiai hae ieed a fa ha defie i. A e capitalized value is the discounted value of its future income: caiaied ae fe eaig dic ae
real-world economics review, issue no. 97 subscribe for free 80 In textbooks, this equation is put more succinctly as: 𝐾 𝐸 𝑟 Looking at this equation, Jonathan Nitzan and Shimshon Bichler note something interesting. The formula ostensibly capitalizes property the stuff that capitalists own. And yet the capitalization equation makes no mention of this stuff. There are no symbols for factories, machines, or infrastructure. Instead, there is only income (E). And that, Nitzan and Bichler observe, is precisely the point. The capitalization ritual tells us how capitalists see the world. Capitalists care not for the things they own. They care about their property rights their right to earn income by putting up an (institutional) fence. Because it reflects an ideology, the capitalization formula is delightfully circular. It defines one monetary sum in terms of another. Nothing in science says that the equation should hold. It holds only because we have convinced ourselves that it should. As Nitzan and Bichler see it, the spread of capitalism boils down to the spread of the capitalization ritual. It allows anything and everything to have a capitalized value. Take music. In 2020, Bob Dylan sold his entire song catalogue to Universal for some $300 million (Sweney, 2020). The truth, though, is that Universal did not buy songs. It bought income. The cigh Da g eed a iabe aa income by some accounts about $4 million per year (Friedman, 2013). Assuming this sum is accurate, Uiea caiaied Da aie b aig a dic ae f 1.3%: 𝐾 𝐸 𝑟$4 ii 0.0133 $300 ii Bob Dylan traded future income (from his property rights) for a lump sum. And Universal traded a lump sum for future income. That is capitalization in action. Regularity from ritual Unsurprisingly, rituals give rise to astonishing regularity. Every Sunday, Catholics gesture the cross. Five times a day, Muslims bow towards Mecca. Regularity from ritual. Like these religious rituals, the eca ia f caiaiai gie ie aihig egaiie. Le hae a k a he. We will start by noting that capitalization is defined only when property changes hands. Put another way, capitalized value is contested until property is sold. Take the example of Donald Trump. He proclaims constantly that his property is worth billion. Ciic ce ha T eie i h fa less. Neither side is correct. Capitalized value is undefined until the property is sold. If tomorrow, Trump sold his business for $1 billion, that would be its capitalized value. In the past, capitalization was poorly defined because property changed hands rarely. An aristocratic family, for instance, might run a merchant business for many generations without ever knowing its capitalized value. Today, things are different. That is because in modern capitalism, partial ownership
real-world economics review, issue no. 97 subscribe for free 81 has become the norm. Portions of firms are bought and sold every second, which means we know capitalized value with exquisite detail. Take Amazon as an example. The business is enormous, employing about 1.2 million people. And yet the unit of ownership the Amazon share is minuscule. One Amazon share buys you about 2 billionths of the company. Because the unit of ownership is tiny, it is trivial to buy and sell. The result is that unlike aristocratic businesses that changed hands once a century, Amazon shares change hands every ecd. A ch, Aa caiaied ae i k eac. A f Ag 12, 2021, i a: Aa ake ca hae ice be f hae $3290 e hae 0.51 bii hae $1.68 ii Why is Amazon capitalized at $1.68 trillion? The answer is that the company has a massive income stream i fi i 2020 ee $21 bii. Dic ha ice a 1.3% ad ge Aa capitalized value: 𝐾 𝐸 𝑟$21.3 bii 0.0127 $1.68 ii Next question. Where did the discount rate of 1.3% come from? The answer: out of thin air. Like the capitalization ritual itself, the discount rate is whatever we define it to be. Capitalists employ the capitalization ritual by ritualistic chig a dic ae ha he dee e. Ria ihi ia. Yes, the whole endeavour smacks of arbitrariness. But that is the nature of ritual. What is important is the regularity to which the ritual gives rise. This regularity is not visible when looking at a single firm. It i b kig a had f fi ha ca ee i. O ha f, e Fige 1. I have plotted here data for the profit and capitalization of US public firms dating back to 1950. Each point is a firm in a given year. (There are about 200,000 observations in total.) From this sea of firms, the regularity of capitalization is unmistakable. Capitalization is proportional to profit discounted at a rate of 7%. Regularity from ritual.
real-world economics review, issue no. 97 subscribe for free 82 Figure 1. Profit and capitalization of US firms, 1950 2017 Each point represents a US firm. Color indicates the year of observation. The black line shows how capitalization relates to profits for a discount rate of 6.8% the average found in the data. For data sources, see Sources and methods. The discount rate Is there something special about the discount rate of 7%? The answer is yes and no. That rate is special i he ee ha US caiai hae deeed i be e. B hi ae i baa i he sense that it has no deeper meaning. US capitalists discount at 7% because that is the norm they have accepted. Gesture the cross. Discount at 7%. Regularity from ritual. How does this regularity come to exist? In the past, it was by decree. Much like church clergy decreed he ae f he H Tii, he deceed he e ae f dic: Ui he eegece f caiaiai i he feeh ce, [he e dic rate was] seen as a matter of state decree, sanctioned by religion and tradition, and modified by necessity. The nobility and clergy set the just lending rates as well as the tolerated zone of private divergence, and they often kept them fixed for very long eid f ie (Nia & Biche, 2009). Tda, he e dicnt rate still has an element of decree. Governments (via central banks) set the benchmark interest rate, which in turn affects the benchmark discount rate on equity. If you are a finance outsider, you may be wondering what the interest rate has to do with discounting. The two rates are related because the principle of capitalization is the reverse of the principle of interest.
real-world economics review, issue no. 97 subscribe for free 83 Here is an example. Suppose you put $100 in your savings account at 5% interest. In a year, you would have $105. Now ask yourself how much would you pay now to receive $105 in a year? The answer, if ae a aia caiai, i $100. Tha i he ha d ea $5 he i a aig account for a year. So by thinking about interest, you have capitalized a $5 future income at $100. Although the principle of discounting stems from the principle of interest, the two rates (benchmark discount and interest) are not the same. This we can see from history. But before we get to the data, e hik a bi e ab he dicnt rate. Here is some simple math. Start with the capitalization equation: 𝐾 𝐸 𝑟 Now rearrange for the discount rate r: 𝑟 𝐸 𝐾 The ecd eai defie he effecie dic ae a hich ie caiaie ice. I ca i he effecie ae becae he caiaiai ia i echica ab future income, which is unknown. In practice, capitalists pin down earnings E by looking at the recent past (i.e. the last quarterly income report). Assuming this habit, the effective discount rate is the ratio of present income and present capitalization. F a ae cacai, e e Aa. La ea, he ca aked i $21 bii i fi. And today, its market cap is about $1.68 trillion. So Amazon is currently capitalized at an effective discount rate of 1.3%: 𝑟 𝐸 𝐾$21.3 bii $1680 bii 0.013 This effective discount rate varies between firms. And it varies within firms over time. This variation deserves a closer look. The benchmark discount rate We will start with the benchmark discount rate. I define this benchmark as the average of the effective discount rate across all firms. The math: to calculate the benchmark discount rate, we first take every public firm (with available data) and divide income by capitalization. That gives the effective discount rate for each firm in a given year. The benchmark rate is then the average across all firms in that year. (Because we are dealing with growth rates, I calculate the average using the geometric mean.)
real-world economics review, issue no. 97 subscribe for free 84 Figure 2 shows how the US benchmark discount rate varied over the last 70 years. It oscillated around the average rate of 7%. But there are conspicuous departures from this average. In the mid 1970s, for instance, the benchmark rate soared to a high of 20%. What happened during this period? Figure 2. The US benchmark discount rate I have plotted here the trend in the average discount rate across all US firms in the Compustat databases. The dashed horizontal line is the average benchmark since 1950 (geometric mean, weighted equally across years). For data sources, see Sources and methods. Given that the principle of capitalization works by reversing the principle of interest, one might think that the benchmark discount rate is a simple reflection of the rate of interest. If so, the discount-rate spike in the 1970s should correspond with an interest-rate hike. While reasonable, it turns out that this expectation is wrong. Figure 3 tells the story. Here I compare the benchmark discount rate to US interest rates. (I have used the US Federal Reserve interest rate the so-caed effecie fedea fd ae. Thi i he iee ae a hich bak ade e ih he Federal government. It sets the benchmark for all other interest rates.) We can see in Figure 3 that interest rates did spike in the past. But the hike came about 7 years after the spike in the discount rate. Clearly, then, interest rates are not driving how US capitalists discount ice. T dead caiai hed behai, e ook elsewhere.
real-world economics review, issue no. 97 subscribe for free 85 Figure 3. The US benchmark discount rate vs. the FED interest rate The blue line shows the trend in the average discount rate across all US firms in the Compustat databases. The red line shows the US FED interest rate. For data sources, see Sources and methods. While only loosely related to the rate of interest, it turns out that the benchmark discount rate is related to another rate: the rate of inflation (Fig. 4). The inflation rate is a measure of how rapidly prices tend to ie. Becae ice chage aie b cdi, hee i ch hig a the ae f ifation. Instead, think of inflation as similar to discounting: it has an average rate surrounded by a sea of deviation. The ceheie eae f he aeage ae f ifai i caed he GDP defa. (I measures the average price change of all the commodities included in the calculation of GDP.) In Figure 4, I compare this inflation rate to the benchmark discount rate. The two rates are clearly connected. When the benchmark discount rate spiked in the 1970s, so did the rate of inflation.
real-world economics review, issue no. 97 subscribe for free 92 Figure 8 shows the trend. I have plotted here the markup as a function of relative capitalization among all US public firms (since 1950). Each point indicates the median markup when firms are grouped by relative market cap. (I have normalized capitalization so that the median cap in each year is 1). It is easy to spot the trend. The markup grows reliably with capitalization. When US investors capitalize income, it seems they prefer that profit be reaped on a fat margin. Why do investors award greater capitalization to firms with a higher markup? Perhaps it again comes down to perceptions of risk. Consider two companies with similar-sized profits. One company has mammoth sales but a razor thin markup. The other company has smaller sales, but a fat markup. Which e d ie dee e ik, ad dic e ee? To make the question concrete, consider the difference between Walmart and Apple, summarized in Table 1. In order-of-magnitude terms, the two firms have similar-sized profits. But they take different routes to this windfall. Walmart has enormous sales and a thin markup. Apple has smaller sales and a fat markup. Table 1. Walmart vs. Apple Walmart Apple Profit (billions $) 21 57 Sales (billions $) 520 275 Markup 4.0% 20.9% Capitalization (billions $) 400 2127 Effective discount rate 5.1% 2.7% Sources: Walmart 2020 Annual Report, Apple 2020 Annual Report. Ie, i ee, efe he Ae e fi. Ee hgh Ae fi i f iia ie Waa, ie ead Ae ih fa e caiaiai. The diffeece? Waa ha a hi markup, Apple a fat one. Framed in terms of the capitalization ritual, investors discount Walmart more steeply than Apple. They obviously have reasons for doing so, but these reasons need not be objective. That is because we are dealing with an ideological Russian doll rituals within rituals within rituals. The finance ethos A baic icie f he gai f ideg i ha hd ak ideg abia elements. Faith in your ideology hinges on it having the appearance of higher truth. You must therefore avoid plain discussion at all costs, since it has the unfortunate effect of shedding light on the arbitrariness of your ideas. And so it is with capitalization. Finance textbooks read like tomes of physics, bombarding the reader with opaque symbols and complex equations. The mathematics give capitalization the appearance of cieific h. De hi ea ha fiace i a had ciece? The answer is a hard no.
real-world economics review, issue no. 97 subscribe for free 93 Finance does not describe our social world. Finance defines it. Finance outlines the rituals whereby capitalists impose order onto society, turning the qualities of ownership into a single quantity. Finance, Jonathan Nitzan and Shimshon Bichler observe, is the ideology of our time: The ciece f fiace i fi ad fe a collective ethos. Its real achievement is not objective discovery but ethical articulation. Taken together, the models of finance constitute the architecture of the capitalist nomos. In a shifting world of nominal mirrors and pecuniary fiction, this nomos provides capitalists with a clear, moral anchor. It fixes the underlying terrain, it shows them the proper path to follow, and it compels them to stay on track. Without this anchor, all capitalists whether they are small, anonymous day traders, legendary investors such as Warren Buffet, or professional fund managers like Bill Gross would be utterly lost. Finance theory establishes the elementary particles of capitalization and the boundaries of accumulation. It gives capitalists the basic building blocks of investment; i e he h aif hee eiie a eica aiabe; ad i ide he with a universal algorithm that reduces these variables into the single magnitude of present value. Although individual capitalists differ in how they interpret and apply these principles, few if any can transcend their logic. And since they all end up obeying he ae geea e, he e heee ee bjecie ad heefe aeabe cieific dice (Nia & Biche, 2009). Make no mistake, the regularities of corporate finance are majestic in scope. But these regularities stem not from any laws of nature. They are regularities from ritual. Gesture the cross. Discount present income. Perhaps the most important question is where this ritual is headed. Does capitalization have a longterm future? Neoclassical economists like William Nordhaus (2007) think so. He is happy to apply the capitalization ritual to existential crises like climate change. And the net present value of his calculations tells him that we should do essentially nothing. But of course, by applying a heavy discount rate to fe ice, dig hig i ha Ndha aed i he fi ace. I i iaied aah. 3 Back to the present. The ritual of caiaiai i ded b a ie f highe h. Wheee you encounter such a mystique, it is a good bet that you are dealing with ideology. The point of the ie i f kig de he ideg hd. Whe d, ee that the whole hig i a he f cad. The highe h f he H Tii i ha i i a idegica iei f chch ceg. S ih fiace. The diffeece i ha ih fiace, he ceg ae ie they are economists. Acknowledgements I would like to thank the following people for their support: Mike and Joanne Tench, Pierre, Steve Keen, James Young, Brent Gulanowski, Norbert Hornstein, Michael Defibaugh, Robin Shannon, Fernando, Hilliard MacBeth, Grace and Garry Fix, Tim Ward, Joe Clarkson, Tom Ross, and John Medcalf. 3 F a debkig f Ndha ciae-change work, see Keen (2020). For a discussion of how Nordhaus uses the capitalization ritual to discount future income, see Bichler & Nitzan (2018).
real-world economics review, issue no. 97 subscribe for free 94 Sources and methods All data and code for the analysis in this paper are available at the Open Science Framework: https://osf.io/vm4by/ Financial data for US firms comes from Compustat. Data series are as follows: capitalization: number of shares outstanding (series CSHO) × annual closing share price (series PRCC_C) profit (net income): series NI sales: series SALE markup (profit as a portion of sales): NI / SALE Interest rates (Fig. 3) are from FRED series DFF. The GDP deflator (Fig. 4) is from FRED series A191RI1Q225SBEA The effective discount rate For each firm 𝑓, I defie he fi effecie dic ae 𝑟𝑓 as 𝑟𝑓𝐸𝑓 𝐾𝑓 where 𝐸𝑓 i he fi fi ad 𝐾𝑓 i he fi caiaiai (i a gie ea). I defie he aeage discount rate for all firms, 𝑟, as the geometric mean of 𝑟𝑓 over all firms: 𝑟 𝑟1𝑟2⋅⋅⋅ 𝑟 1/ When calculating the effective discount rate, I exclude firm observations with negative profit. References Biche, S., & Nia, J. (2016) A CaP de f he ck ake. Real-World Economics Review, (77), 119 154. Biche, S., & Nia, J. (2018) The Ndha acke: H e caiaiai iiie he c f ciae chage ad i a be f aiabe gh. Real-World Economics Review Blog. https://rwer.wordpress.com/2018/11/05/the-nordhaus-racket-how-to-use-capitalization-to-minimize-the-cost-of- climate-change-and-win-a-nobel-for-sustainable-growth/ Friedman, M. (1994) Money mischief: Episodes in monetary history. New York: Harcourt Brace & Company. Friedman, R. (2013) Bb Da $22 ii da bihig dea: Pe g a. Showbiz 411. http://www.showbiz411.com/2013/07/08/bob-dylans-22-million-dollar-publishing-deal-protest-songs-pay Kee, S. (2020) The aaig bad ecaica ecic f ciae chage. Globalizations, 0(0), 129. https://doi.org/10.1080/14747731.2020.1807856 Nitzan, J. (1992) Inflation as restructuring. A theoretical and empirical account of the US experience (PhD thesis). McGill University.
real-world economics review, issue no. 97 subscribe for free 95 Nitzan, J., & Bichler, S. (2009) Capital as power: A study of order and creorder. New York: Routledge. Ndha, W. D. (2007) A eie f he Se eie he ecic f ciae chage. Journal of Economic Literature, 45(3), 686702. Rousseau, J.-J. (1992) Discourse on the origin of inequality (D. A. Cress, Trans.). Hackett Publishing. See, M. (2020) Bb Da e eie bihig caage iea ic. The Guardian. https://www.theguardian.com/business/2020/dec/07/bob-dylan-sells-publishing-universal-music Author contact: [email protected] ___________________________ SUGGESTED CITATION: Fi, Bai (2021) The ia f caiaiai. real-world economics review, issue no. 97, 22 September, pp. 78-95, http://www.paecon.net/PAEReview/issue97/Fix97.pdf You may post and read comments on this paper at https://rwer.wordpress.com/comments-on-rwer-issue-no-97/