Profits Disappear Only In Equilibrium, Which We Never Reach

Dear U:

Thanks for your important question. In my humble opinion, unless we are in equilibrium, no such equality will occur. But, while we are always tending in that direction, we are never in equilibrium.

You might ask, along the same lines, why are not profits in all industries (apart from risk considerations) not equal. And, also, why do profits, all of them, not fall to zero. I give the same response now: this would indeed occur, were we ever in full equilibrium, but we never attain that situation.

I hope and trust you’ll find this of help to you in your deliberations.

Best regards,

Walter

From: u

Sent: Monday, July 22, 2019 9:31 AM

To: wblock@loyno.edu

Cc: wbarnett@loyno.edu

Subject: Fw: greeting from Istanbul again

Dear Professors Block and Barnett,

It’s been a very long time since our correspondences. But I still consider the issue unresolved as Prof. Barnett has not replied to my last e-mail addressing the questions he raised. I would very much appreciate it if either of you can enlighten me on the matter or would refer me to someone who can.

Austrian theory on this topic is eloquently summarized by Rothbard in the following quote:

“Time Preference is the insight that people prefer “present goods” (goods available for use at present) to “future goods” (present expectations of goods becoming available at some date in the future), and that the social rate of time preference, the result of the interactions of individual time- preference schedules, will determine and be equal to the pure rate of interest in a society.

The economy is pervaded by a time market for present as against future goods, not only in the market for loans (in which creditors trade present money for the right to receive money in the future), but also as a “natural rate” in all processes of production. For capitalists pay out present money to buy or rent land, capital goods, and raw materials, and to hire labor (as well as buying labor outright in a system of slavery), thereby purchasing expectations of future revenue from the eventual sales of product. Long-run profit rates and rates of return on capital are therefore forms of interest rate. As businessmen seek to gain profits and avoid losses, the economy will tend toward a general equilibrium, in which all interest rates and rates of return will be equal, and hence there will be no pure entrepreneurial profits or losses.”

If this is true, then over the very long-term and taken as a whole, the average rate of return on equity should be roughly equal to average long-term corporate bond yields (which the Fed does NOT control). However, they are not and never have been. I have pointed out in my last e-mail below that the average rate of return on equity has been 12-14% while long-term corporate bond yields (as well as the 10-year US Treasury yield) has been about half that (6-7%). This data has been consistent going back nearly a century. You are welcome to double check any source you like.

My question is simply this: If entrepreneur-capitalists will bid up and bid down factor prices to their discounted marginal value productivity, which, in turn, reflects and is equal to the prevailing rate of social time preference (interest rates), then what explains the divergence pointed out above? How is it that I can earn an average annual rate of 12-14% if I invest in an S&P 500 index fund and just hold it for decades but will earn only half that if I buy & hold the long-term bonds of the very same basket of corporations? The prices of the stocks should be bid up and/or the prices of the bonds should be bid down until their respective average returns over time converge at whatever rate that reflects the prevailing time prefence. The very long-run averages should equalize. Yet the only thing that remains stubbornly equal is the spread between the two.

So either I’m missing something huge and will look like an idiot or the Rothbardian theory of time preference is wrong in a huge way.

Best Regards,

U

________________________________________

From: u

Sent: Wednesday, August 8, 2018 2:29 PM

To: Walter Block <wblock@loyno.edu>

Cc: wbarnett@loyno.edu <wbarnett@loyno.edu>

Subject: Re: greeting from Istanbul again

Below is an article written by Warren Buffett for Fortune Magazine in 1977. In it he explains that the roughly 12% rate of return on equity capital has remained so consistent that he considers it to be effectively equivalent to the fixed coupons of bonds. He even coined the term “equity bond” to drive the point home. A quick look at the returns of the S&P 500 index since the article was published will reveal that the figure still hovers around the same 10-12%.

By the way, anyone who studies Buffett’s shareholder meetings will recognize that his definition of “profits” is synonymous with “cash” (what he calls Owner Earnings). So he leaves no room for fuzzy opinions in these figures.

Profits soar here, plummet there but in the AGGREGATE and OVER TIME American corporations have returned an average of 12% on equity. Buffett points out that roughly half were paid out as dividends. Another 2% was lost to inflation, leaving 4% to be reinvested for future growth. Finally, US population growth of roughly 1% brought that increase in equity capital down to 3%.

And that, in a nutshell, is how we achieved an average of 3% GDP growth since (let me rephrase) the dawn of the industrial revolution.

http://fortune.com/2011/06/12/buffett-how-inflation-swindles-the-equity-investor-fortune-classics-1977/

Buffett: How inflation swindles the equity investor …

fortune.com

The central problem in the stock market is that the return on capital hasn’t risen with inflation. It seems to be stuck at 12%.

I’d love to continue our conversation as I am still confused as to the source of these constant rate of returns. Because its existence is indisputable.

Kind Regards,

U

________________________________________

From: Walter Block <wblock@loyno.edu>

Sent: Tuesday, August 7, 2018 6:36 PM

To: U

Subject: RE: greeting from Istanbul again

It appears below. Here it is, again:

From: William Barnett [mailto:wbarnett@loyno.edu]

Sent: Monday, July 30, 2018 10:50 AM

To: Walter Block

Subject: RE: greeting from Istanbul again

W,

First, there is no such thing as an ERE; it is a logical impossibility as are such concepts as a square circle and a three-sided square.  Therefore, your statement “that we’ve never been at equilibrium, ERE, all during that time” is correct a fortiori.

Second, I challenge the assertion that “there is a rate of return on equity capital that has remained astonishingly constant almost since the dawn of capitalism (roughly 12%). And it has hovered around that level regardless of the changes in interest rates and time preferences throughout that time.”  I know not of any source for that alleged fact, but would challenge it on a number of points, not necessarily in order of importance:

1. From the economic perspective, in contradistinction to that of accounting, I think it impossible, to separate the owners’ capital into owners’ entrepreneurial capital and owners’ capitalist capital; i.e., I think MNR is correct to concentrate on “capitalist-entrepreneurs” (MES+P&M Sch. ed., 509) because I do not think these two aspects of action (capitalist function-“invest [saved] money in factors [of production]” [MES+P&M Sch. ed., 299] and entrepreneurial function–“determining the employment of the factors of production” [HA Sch. Ed., 288]) may be distinguished save in the fairy-tale world of the ERE.

2. Moreover, as the aphorism has it: “Cash is a fact, profit is an opinion.”

3. There is no such thing as a rate of return on equity capital – this is a highly aggregated concept that in reality is meaningless.

4. Does the 12% include the capital gains as well as operating profits?

5. And, that such a return, if it existed in reality, has remained roughly constant since the dawn of capitalism is an invalid statement, in my opinion. There is no agreement on when capitalism began, or even exactly what is meant by capitalism.

6. Who made these calculations and on what basis?  Where did the data come from and how inclusive and accurate is it?  What methodology was used?

Third, and I think this goes to the heart of what is at issue, MNR (and LvM) both consider business profits to be non-existent in the ERE, so there can be no “rate of return.”  On the other hand, both see that  in the real world; i.e., outside of the ERE, if for no other reason that in the real world action is continuous, and profits arise from actions that necessarily involve speculation as to the (future) outcome of these very same current actions because “the future is unknown and unknowable,” and thus profits are transitory, so there can be no “rate of return.”

B

From: u

Sent: Tuesday, August 07, 2018 7:44 AM

To: Walter Block

Subject: Re: greeting from Istanbul again

I’m afraid I haven’t received a reply from Prof. Barnett.

Sent from Outlook

________________________________________

From: Walter Block <wblock@loyno.edu>

Sent: Tuesday, July 31, 2018 5:44:45 AM

To: ‘William Barnett’

Cc: uygaraktan@hotmail.com

Subject: RE: greeting from Istanbul again

Dear Bill:

Thanks.

Dear U:

Your question is more in the field of my friend Bill  than mine, so I asked him to reply to your question. See below.

Best regards,

Walter

Walter E. Block, Ph.D.

Harold E. Wirth Eminent Scholar Endowed Chair and Professor of Economics

Loyola University New Orleans

New Orleans, LA 70118

wblock@loyno.edu

From: William Barnett [mailto:wbarnett@loyno.edu]

Sent: Monday, July 30, 2018 10:50 AM

To: Walter Block

Subject: RE: greeting from Istanbul again

W,

First, there is no such thing as an ERE; it is a logical impossibility as are such concepts as a square circle and a three-sided square.  Therefore, your statement “that we’ve never been at equilibrium, ERE, all during that time” is correct a fortiori.

Second, I challenge the assertion that “there is a rate of return on equity capital that has remained astonishingly constant almost since the dawn of capitalism (roughly 12%). And it has hovered around that level regardless of the changes in interest rates and time preferences throughout that time.”  I know not of any source for that alleged fact, but would challenge it on a number of points, not necessarily in order of importance:

1. From the economic perspective, in contradistinction to that of accounting, I think it impossible, to separate the owners’ capital into owners’ entrepreneurial capital and owners’ capitalist capital; i.e., I think MNR is correct to concentrate on “capitalist-entrepreneurs” (MES+P&M Sch. ed., 509) because I do not think these two aspects of action (capitalist function-“invest [saved] money in factors [of production]” [MES+P&M Sch. ed., 299] and entrepreneurial function–“determining the employment of the factors of production” [HA Sch. Ed., 288]) may be distinguished save in the fairy-tale world of the ERE.

2. Moreover, as the aphorism has it: “Cash is a fact, profit is an opinion.”

3. There is no such thing as a rate of return on equity capital – this is a highly aggregated concept that in reality is meaningless.

4. Does the 12% include the capital gains as well as operating profits?

5. And, that such a return, if it existed in reality, has remained roughly constant since the dawn of capitalism is an invalid statement, in my opinion. There is no agreement on when capitalism began, or even exactly what is meant by capitalism.

6. Who made these calculations and on what basis?  Where did the data come from and how inclusive and accurate is it?  What methodology was used?

Third, and I think this goes to the heart of what is at issue, MNR (and LvM) both consider business profits to be non-existent in the ERE, so there can be no “rate of return.”  On the other hand, both see that  in the real world; i.e., outside of the ERE, if for no other reason that in the real world action is continuous, and profits arise from actions that necessarily involve speculation as to the (future) outcome of these very same current actions because “the future is unknown and unknowable,” and thus profits are transitory, so there can be no “rate of return.”

B

From: U

Sent: Saturday, July 28, 2018 8:46 AM

To: wblock@loyno.edu

Subject: greeting from Istanbul again

Dear Professor Block,

I’d be grateful if you could enlighten me on the following question. I was reading Rothbard’s Man, Economy and State. My question is regarding the part where he talks about “entrepreneurial profits” being “ephemeral” because the undervaluation of a factor discovered by an entrepreneur (which made ‘pure profits’ possible) will soon be bid up by competition so that the entrepreneur’s income (in an ERE) would return to the prevailing time preference. Rothbard concludes, therefore, that it is absurd to even talk about “a RATE of return” in this regard.

And that is where I’m confused because there is a rate of return on equity capital that has remained astonishingly constant almost since the dawn of capitalism (roughly 12%). And it has hovered around that level regardless of the changes in interest rates and time preferences throughout that time.

What am I missing/misunderstanding here?

Kind Regards,

U

Sent from Outlook

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9:00 pm on August 29, 2019