Philadelphia Reflections

Capitalism Explained

Capitalism began when the Industrial Revolution began. You have to go back to its beginnings to find a time when pretty much everybody understood the whole process. Capitalism began to get rolling when banks entered the picture, meeting with both creditors and debtors. Robert Morris didn't invent capitalism, he was just the leader in understanding the role of banks.
Like most innovators, Morris took one side of it and got rich. When the predators caught on and sent him to debtor's prison, he realized the bankruptcy laws needed to be changed. When George Wahington visited Morris in the Walnut Street debtors prison, the two of them had the clout to get bankruptcy laws changed. And Morris was released.

Back in those days, banks were rudimentary and Morris was running the country. He realized that banks created money when they made a loan, because two people, the debtor, and the creditor, were able to write checks on the same money. That quirk created an incentive for both sides to make loans and for the banks to make a profit. The banks made the loans, and if the debtor couldn't repay, he went to jail until he did. Shakespere, in the Merchant of Venice, depicted that state of affairs in the Sixteenth Century fairly accurately. By Morris's day, things had progressed from a pound of flesh to debtor's prison, but that didn't help much, because who in the world would borrow money on those terms? So bankruptcy was changed to release the defaulting debtor, upon surrendering all of his personal assets to discharge the debt.

So, now there were two sources of funds for satisfying creditors -- the extra interest debtors paid if their personal assets seemed shaky, and all of their personal assets if that didn't suffice. It was up to the creditor or the bank to investigate how adequately that should suffice, so both sides were taking a risk. My next-door neighbor had the crust at the age of 19 to ask a banker for a loan to start a business, in spite of the fact that he had no personal assets at all. Forty years later, he had a thousand employees and a lot of gratitude to the banker who took a chance on him. So he joined the bank's board of directors at no salary. By contrast, a lot of other debtors were turned down for loans, because the banker wouldn't take a chance on them. They sulked a lot about bankers who wouldn't make a loan unless you didn't need one. Those tears were not always genuine, but sometimes they were, and that's capitalism for you.

Never the less, although the incentives had been improved, they weren't enough to make capitalism boom. People with generous means still wouldn't make loans on the terms of all their personal assets risked, because they had too much to lose. So life insurance flourished, and bonds, where the creditor's loss was limited to the amount of the assets put up as security for the loan. Once again, the creditor was protected against overstatement of the debtor's net worth.

That's about all there is to capitalism, and it seemed to be enough until the government entered the equation with things like student loans and credit default swaps. If we are going to do things like that, we will need an elaborate government credit investigative system, which will raise the resulting interest rate, perhaps to a higher level than the formerly balanced system can sustain.

Originally published: Saturday, August 10, 2019; most-recently modified: Saturday, August 10, 2019