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Saturday, August 4, 2012

Limited Liability and Bursting Bubbles


This occurs in every market, not just petroleum.

The following is an account of how the financial system and corporations evolved, or rather didn’t. As designed, they have been spreading the monopolistic control of the privileged class while protecting them from the consequences of their actions since the 1550s. The system has always been unstable and has been producing bubbles and crashes since it came into existence, and for all the same reasons.

Why doesn’t it get fixed? Because the few who benefit without risk are still largely in control, and the lure of quick profit too often trumps real investment in the future. The instant fix of the gambler runs our financial systems. Everyone but the gamblers pays when luck turns against them, as it always does.
  

 

The First Corporations and Stocks

“Companies such as The Russia Company (1555) and the East India Company (1600) were charter companies that evolved from loose umbrellas covering a recurring series of self-liquidating ventures to permanent entities possessed of substantial assets in the form of ships, trading posts, and inventories. The East India Company, for example, originally raised capital (the joint stock) for each voyage separately and at the end, the property was divided among the subscribing venturers. As the company acquired more permanent property, it became increasingly difficult to identify assets with individual voyages and it became necessary to allocate them (and hence profits) among voyages. This problem was lessened by raising capital subscriptions for four-year terms, one quarter to be paid up each year.” [1]

The first corporations were colonial monopolies, given to the relatives and friends of royalty, which exploited the resources of conquered territories and peoples. They traded spice, and furs, and slaves, while spreading violence and disease. No wonder that stocks should be called the same name as a device of humiliation, punishment, and social control.

 

The Introduction of Stock Trading

 In 1657, “the principal of permanently invested capital and transferable shares was adopted. As a result, future distributions no longer represented divisions of assets at the conclusion of a venture, but rather “dividends” paid from profits.” [2]

This was the start of the separation of responsibility from profit, by having the investor included as part of a pool of capital rather than part of the venture itself. 

 

The Largest Private Commercial Empire

In 1670, “King Charles II issued a grant for the Company of Gentlemen Adventurers Trading into Hudson Bay, known today as the Hudson’s Bay Company or the Bay. The charter provided a monopoly over trade in the lands fed by rivers flowing into Hudson Bay, the equivalent of 40% of modern Canada. Known as Rupert’s Land until after Confederation, it was history’s largest private commercial empire. To manage such a huge trading area required a well-capitalized organization and permanent business operations.”[3]

Corporate monopolies ruled like kings then, and are trying, along with their neoconservative neoliberal allies, to return us to that situation. Serfs are so much easier to deal with than citizens.

 

 The First Time It All Crashed

 From 1690 to 1720, “periods of boom and crisis succeeded each other in the market, culminating in a major crash in 1720. Known as the South Seas Bubble, its crash is associated with the South Seas Company organized in 1711 to obtain a government monopoly on trade in South America and to acquire government debt cheaply, thereby establishing a firm base of assets.
“The idea was that the company would accept all unfunded government debt (debt that did not have a specific revenue source earmarked for its repayment) at par in subscription for its shares. The theory was that ownership of that debt by the company would provide it with an undoubted “fund of credit” against which it could borrow to finance its activities.
“In 1719, a company production boom began in England on a highly speculative basis. As the boom progressed, the stated objects of many of the companies became increasingly improbable, so that sceptical observers referred to them as “bubble companies.”
“In early 1720 the South Seas Company took advantage of the speculative fever by successfully competing with the Bank of England (then privately owned) to win the right to undertake a new scheme involving national debt. The scheme called for the company, as before, to buy in outstanding government debt (this time funded debt) in return for subscriptions of shares.
“This government-abetted scheme for share price inflation through treating capital proceeds as income met with ill-deserved success. That very success created problems, however, for there was not enough cash in the country available for investment to buy up the bonus shares. So the shares were sold for very little cash down and credit was extended for the remainder of the price, the shares themselves being accepted as security.
“To eliminate competition, the company encouraged parliament to pass the so-called, “Bubble Act.” Effective June 24, 1720, prohibited the offering of shares for public subscription by companies that did not have a charter or that had a charter for activities other than those for which it was raising money.
“Two months later, the South Seas Company instigated legal action against four other companies for contravention of the Bubble Act. A rapid fall in price shares of the companies attacked resulted in margin calls. These triggered liquidation off shareholdings, thereby putting pressure on the share prices of all companies, including the South Seas Company. In the space of less than two months the company’s shares fell from a peak of £1,000 to £180. The rapid collapse of the boom left the fledgling capital market sadder but not permanently wiser and led to a prolonged distrust of joint-stock companies that set their evolution back for a century.” [4]

So, 1929 was far from the first great crash, and 2008 will not be the last. This shows that instability has been inherent in the system since its beginnings. Again and again, lack of effective regulations and rampant speculation has brought down the economy and generated widespread suffering.
  

The Solidification of Limited Responsibility for Unlimited Profit

From 1825 to 1856, “spurred by the Industrial Revolution and the expansion of the British Empire, Britain passed parliamentary measures that effectively created the legal framework for the modern company. By the end of this period a company could obtain legal status through registration. The investor had no liability beyond the amount invested in the company shares; creditors had no recourse to a limited company’s investors. In addition the public company could have any number of shareholders.” [5]

Here is where it became possible to gamble on the numbers rather than investing in actual enterprises. The gambler takes no responsibility for the actions of the thing invested in. He is a bank machine that is turned into a VLT by speculation and the pursuit of quick profit from stock trading, rather than as dividends from the actual venture. To be invested, you must be part of what you invest in; you should take a portion of the risk equal to the size of the investment and possible benefit. That might discourage gambling and corruption.
  

Responsible Investing for Reasonable Dividends

 Something needs to be done. This self-service cycle of bubble and crash has been going on for over 400 years. I think it’s time we admit the system isn’t working. As democracy sweeps the world, so to must economics that benefit as many, rather than as few, people as possible, with exploitation. Only then can a sustainable working global economy be created.



[1] Milburn, J. Alex (John Alexander). “Accounting Standards in Evolution,” 2nd.ed. Toronto: Pearson Education Canada Inc., 2001.
[2] Milburn, J. Alex (John Alexander). “Accounting Standards in Evolution,” 2nd.ed. Toronto: Pearson Education Canada Inc., 2001.
[3] McKenzie-Brown, Peter. “In Balance: an account of Alberta’s CA profession, 1910-2000.” Canada: Chartered Accountants of Alberta, 2000.
[4] Milburn, J. Alex (John Alexander). “Accounting Standards in Evolution,” 2nd.ed. Toronto: Pearson Education Canada Inc., 2001.
[5] McKenzie-Brown, Peter. “In Balance: an account of Alberta’s CA profession, 1910-2000.” Canada: Chartered Accountants of Alberta, 2000.

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