I return to a theme that apparently only I ever talk about: the economic meaning of the phrase, "international capital flows."
You may think I'm exaggerating. You may think that what I am about to write is widely understood. You would be wrong. Either I'm dead wrong about what I'm saying, or virtually the entire economics profession in the financial press is confused about this topic. You be the judge.
PHYSICAL CAPITAL FLOWS
Let's talk about physical capital flow. I got this example from Arthur Robinson. He has a research institute in southern Oregon. He built this facility out of spare parts and scrap metal. It is self-funded. There is no government money involved. Robinson is better informed about scrap metal than anyone I know.
A few years ago, he told me this story. An American company that was involved in manufacturing went bankrupt. It offered its plant for sale. Its price was based on scrap metal prices. The company sold the entire plant to a group of Chinese businessmen. The Chinese businessmen sent a crew to the USA to take apart the plant. The crew disassembled the plant, shipped the parts to the West Coast, loaded them onto ships, sent the ships to China, transported the parts to a new location, and reassembled the plant.
This is capital flow. It is capital flow on a scale that we can barely comprehend. It is a real-world example of the transformation of the modern economy. A growing economy moves more and more to the provision of services, especially financial services. Manufacturing is transferred to underdeveloped nations. In this example, it was literally transferred. This process is easy to understand, but it is not often that we see something like this. In fact, we don't see it. At most, we hear about it. It gets virtually no attention. But there is no question that this is capital flow.
DIGITAL CAPITAL FLOWS
What is called capital flow is not capital flow. We have in our minds some kind of mental image of physical capital flow. Our image is something like that plant that was sold, disassembled, transported, and reassembled. But something like this is exceedingly rare. In other words, we are analyzing the modern world, and especially capital investments, in terms of a mental model that we have never actually seen. So, something is wrong with our conceptual model. When your conceptual model of what happens 24x7 is built on the image of a transaction that almost never happens, you had better start rethinking your conceptual model. Does this make sense so far?
As I have repeatedly written, digital money doesn't flow across borders. Money flows when we are talking about immigrants in the United States who send hundred-dollar bills back to the folks back home. But that is not what we are talking about when we discuss international flows of financial capital.
We are told that China is worried about capital flows from the West. Or, in an updated version, China now wants capital flows from the West. In fact, "China" doesn't want anything. Communist Chinese apparatchiks want things, and they tell Chinese central bankers to manipulate the money supply in order to achieve these things. But, I digress.
We are told that people in the West are sending capital to China. No, they aren't -- not if we mean money.
Somebody who wants to invest in China has to buy an asset that is in China. He has to buy the asset in Chinese currency if he is going to literally invest in China. He may be able to buy something with U.S. dollars, but that money is going to remain in an American bank.
Say that somebody in China wants to transfer ownership of something at some price. Maybe he is willing to accept digital dollars in an American bank. Why? Because he wants to buy something in the United States. Maybe he wants to buy real estate. It doesn't matter what he wants to buy. The point is this: he is going to buy it with U.S. dollars. Those dollars are going to be in a bank that is regulated by the federal government, especially by the Federal Reserve System. There are no digital dollars sloshing around in the world that are not regulated by the United States government and the Federal Reserve System. again, I'm talking about digital dollars. Yes, there are paper dollars being exchanged outside the United States in Third World countries, and that really is capital flow. But that is not what is discussed in articles on capital flows.
When somebody in the United States sells dollars and buys Chinese yuan, this pushes up the value of the Chinese yuan. Somebody in the United States who wants to hire labor, or buy real estate, or buy whatever in China is going to have to use yuan, unless the seller wants to get a bank account in the United States. This much is clear: neither digital yuan nor digital dollars cross invisible lines called borders. Ownership changes. Digits stay put.
ENTREPEURIAL CAPITAL FLOWS
The American investor has an idea that there is an undervalued asset in China. He wants to buy the asset, hold it for a time, maybe restructure it in some way, and when he is finished, it will generate a stream of income in Chinese yuan.
The asset in China previously was owned by a Chinese investor. He sold the asset to the foreign investor. The foreign investor has now become an entrepreneur in China. He thinks he has a way to make money in China. He sees an undervalued resource, and he buys it. In other words, he is an entrepreneur and a capitalist.
What is being imported into China is not capital in the normal sense of the word. But in the most important sense, it is capital. What is being imported into China is entrepreneurial judgment. Some foreigner thinks he sees a better way of allocating resources inside the borders of China. This affects the price of capital in China. The price of capital goes up. I am talking about specific capital. Some entrepreneur buys a specific piece of land, hires a specific group of laborers, and produces a specific product. Somebody in China could have done this, but the person in China did not see the opportunity. The foreign investor sees the opportunity, and he takes advantage of it. But he takes advantage of it, not by exporting money into China, but by exchanging digital money in the United States for digital money in China. There is an exchange of ownership. Capital remains inside the national borders.
In a crucial sense, capital has been transported through this exchange of ownership. This capital is entrepreneurial capital. It is vision. It is the ability of somebody outside the borders of China to spot an opportunity in China, and then take advantage of it. This is standard entrepreneurship. Entrepreneurship is not easily limited by borders. In fact, investment ideas spread across borders more effectively than anything other form of capital.
Whenever we read about capital that is flowing into China, we never read about what is really going on here, namely, entrepreneurial vision on one side of the borders of China is now being applied inside the borders of China. Entrepreneurial vision is the most important of all forms of capital. Entrepreneurship, meaning the ability to forecast the future accurately and plan for it efficiently, is a unique skill, and only a relative handful of people ever get rich by means of it. It is incredibly valuable.
Capital of this sort is flowing into China. It is being applied inside China. Skilled entrepreneurs from outside China are taking advantages of opportunities inside China. Chinese entrepreneurs did not see these opportunities. As a result, Chinese residents are getting richer, but not because dollars are in some way flowing across the border into China. Dollars are not flowing across the border into China. Rather, ownership is being exchanged across borders. Because of the exchange of ownership, entrepreneurial vision, which had been outside of China, is now imported into China. Chinese residents benefits, because entrepreneurial vision is what makes the world wealthier. It involves vision, and it involves thrift. It involves the reallocation of resources. This can be done internationally. It can also be done across the street.
The significant form of capital that is flowing into China is not disassembled factories. It is also not digital dollars, pounds, or euros. What is flowing into China is entrepreneurial vision.
CONCLUSIONS
Chinese entrepreneurs are catching on. Something in the range of a thousand Chinese investors became billionaires in China in 2014. The freeing up of the Chinese economy is making this possible.
If the Chinese government were to inaugurate a stable currency by firing all the economists of the People's Bank of China, and ordering the PBOC to freeze all holdings of assets, China would get richer. Second, the government would auction off all assets of the state banks, which would be closed down. Then the government would pass a law authorizing foreign ownership of any form of assets in China. More capital would flow into China. I don't mean dollars. I don't mean pounds. I don't mean euros. I mean entrepreneurial vision. People from outside of China would start investing their ideas inside China, because they would believe that they could get their wealth back out at any time. By getting wealth out, this means selling it to somebody for digital currency or gold.
The key to productive capital flows is liberty. The key is attracting the best investors in the world. If a nation has a free society, its legal system enables anybody who has a good idea to implement it inside the nation's borders, and then reap whatever rewards the idea generates. It doesn't matter where that person lives. If he lives outside the nation's borders, who cares? The main thing is this: people inside the free society's borders participate in the productivity that is generated by the entrepreneurial vision of the investors. This is how nations get wealthier. They attract the most important form of capital: entrepreneurial vision.
This is not how the media or the economics textbooks discuss capital flows. This reveals that the people who write the textbooks and the articles in the financial media do not understand economic theory.
© 2022 GaryNorth.com, Inc., 2005-2021 All Rights Reserved. Reproduction without permission prohibited.