Have you ever wondered where the advancement of your wealth comes from in an equity? In a bond it comes from the coupon rate. In a $1000 bond with a 5% coupon, your wealth advances $50/yr. This is actual interest and can be reinvested for compounding or used for spending. A Bond therefore is a kind of legal contract offering you a money motor called cash flow.
A stock OTOH is a piece of property. It’s ownership and it’s value is indeterminate. For example more stock can be created or some can be bought back. It’s only worth what someone will pay you for it. If you own 1000 shares of BRK.B you own a percentage of BRK.B. You can trade your BRK.B for money but until you do that you just own some property, same as a house or a farm or a car. So what makes a stock valuable? We glibly buy stocks and quack about the “magic of compounding”, but on it’s own property does not compound. On any given day it can be worth more or worth less or even become worthless. What’s the motor for a stock?
Henry Bessemer patented a process for making steel in 1856. The process made steel purer stronger and easier. The process existed in other parts of the world (cold blast) since the 11th century. The story is an intriguing look into creativity and mythology and perhaps a dollop of theft, but none the less the blast furnace method of steel production ensued. This new steel compared to cast iron lasted 10 times longer, was malleable and could be produced in vast quantities. Bessemer’s process brought down the price and improved the quality. Because of Bessemer’s process Minnesota’s Mesabi range of Iron Ore went from a 6% of need output to 51% and steel workers went to work making steel (imagine all those jobs and lives changed). Cheaper steel allowed rail roads to prosper. A rail was cheaper to make and lasted 10x longer. At one point Chicago was the cross road for 14% of the nations railways. My Grandfather had a second grade education and worked the steel mills in south Chicago his whole life. He raised 6 kids. They were poor but Henry Bessemer’s innovation fed them. My other Grandfather had an 8th grade education. He became a meat buyer for A&P foods. Eventually he worked his way to the C suite as VP. I used to tag along to the Chicago stock yards where gramps would inspect and cull meat to send to the butchers, the meat my other grandfather would feed to his kids. The meat got to Chicago as cattle on the trains, which road the rails so much improved by Bessemer’s process. My uncle (grampa #1’s son) was a butcher who cut up the meat, and the abundance of meat brought down prices and grew strong people with good solid brains. God bless Henry Bessemer where ever you are! The Chicago stock yards are what peaked my interest in commodities trading. There’s gold in them there pens!
What this is, is a description of creative destruction. Creative destruction is the motor that drives stock price. It’s productivity and innovation and a relentless improvement in efficiency. It destroys the inefficient and creates the efficient. It’s a concept born of economist Joseph Schumpterer of the Austrian school which uses Marx’s dialectic as the motor. In Marx’s theory production was static and money flowed from have not’s to haves causing what he thought would be social unrest to the extent the proletariat would rise up and smote their bourgeoisie overlords and usher in utopia. Marx lived in the fossilized society of London and his mistake was misunderstanding human ingenuity and creativity. The sucker was stuck in the mud without the creativity to understand he was in the belly of a fossil not something alive and growing. Unfortunately tens of millions died and lived in abject poverty over his stupidity. Not creative destruction but pure destruction and quenching of the human spirit.
Production is not static so the pie can grow! Not only can the pie grow but you can bake a bigger better pie or a dozen bigger pies! What Schumpterer saw was the real dialectic is between creation and stagnation. The creative dynamo would rise up and pulverize the fossil. The creative dynamo would rise up, eat the fossils lunch and multiply the loaves and fishes (increasing value). The real dialectic was Bessemer’s efficiency of the new steel v the inefficiency of cast iron. The pie expanded and trillions were created out of thin air, and the opportunity flowed to my Grandfathers who each in their own way were able to feed their children, and their children had children. Creative destruction of course predated Schumptlerer he just normalized an understanding. It’s creative destruction, improving efficiency and productivity that is the motor in stocks. That’s were the excess value comes from. Unlike a bond which is pretty much a fixed legal contract creative is a living thing where something is made from nothing.
There are tons of examples of this dynamo. Cyrus McCormick developed a thrashing machine (also developed in Europe). In pre-machine days 1 man could harvest 1 acre of wheat a day with a scythe. Post machine 2 men could harvest 20 acres a day. Henry Ford and his innovation, the recent fracking technology etc etc. Examples enough to prove the path forward. Anything that places a boot on creative destruction is deadly, and as investors you best know which side of your bread has the butter. Creative destruction is the motor impelling us into the future, not the “magic of compounding”
5 Replies to “What’s the Motor?”
I like the term creative destruction. I guess it is likened to market efficiencies. If a new disruptor occurs and has an economic advantage, just like Darwinism, what survives will be the strongest.
The motor for stocks has high upside but due to volatility can be an expensive one to repair.
The term isn’t mine it names the subject matter of entire libraries in B school. Creative destruction doesn’t have a down side. Lack of creative destruction is what is deadly. Communism with it’s 5 year plans or 25 year plans are what is deadly. Capitalism in the face of just rule of law is vibrant. Communism can only exist by theft. Theft of capitalism’s intellectual property. This is what Trump and China is all about. The stakes are not $50 on a washing machine but Trillions of future progress. China wants to steal your motor instead of inventing their own motor.
Nicely rendered image, with just the right amount of menace inherent to progress.
There’s a great amount of fright tinting the destruction in “creative destruction.”
You illustrate the jobs, industries and cities birthed from the process with a great eye for the small details.
Tnx CD. Here is a modern example.
Elon Musk owns a car company but actually Elon Musk owns a battery company. Battery chemistry works by having a small charging voltage pushing huge current into the batteries chemistry for storage. The sun’s light is distributed across the face of the planet. So lets say you have 10 acres of solar panels and some big damn 100v batteries. You can charge your 100v batteries every day all day long with the sun’s kindness. Let’s say you have a long haul truck with no human. Basically it’s a battery and a motor like a portable electric drill with a brain. Electric motors are scary efficient extremely little loss of power except into forward motion, so your AI can drive your truck a fer piece till it needs some juice. Your AI pulls into a service center. The truck has 90V batteries and needs 100V to charge. Your service center has been charging 100V batteries all day long and can deliver 100V day or night PRN. Your AI truck charges up and heads down the road to the next self contained service center 500 miles away. The power distribution is not centralized. No need for long power lines and coal or oil fired plants to make steam to turn turbines. The sun does the trick as it already distributes the power for free. Over time the efficiency of this system wins despite the initial high turn key cost.
There are a lot of jobs on the line in this scenario. Truck drivers and all of that support personal. Truck stops, refining capacity and the need to pump oil, drivers, drivers for oil rigs to refuel transport drivers, cops since AI will be instructed to follow the rules of the road and they can drive all night and all day without fatigue. It’s that scene that freaks people out, but the solution is simply get another job. The FIRE crowd is all about this at least in theory. Why just start a blog, buy some crowd fund, wiggle your pecker at the boss and make your own damn money your own damn way! So what’s the big deal? I read every day how anybody can do it!!! (three exclamations).
What will actually happen is commerce. Economies of scale will happen. Let’s say you own a company and need a few janitors. You employ the janitors but one day realize janitors are damn expensive so you let a janitorial contract to Bills janitors. Bill employs 10K janitors so his operation is exceedingly efficient AND he has competition which forces down price. He picks up your offered contract with the lowest bid. and life goes on. The only thing that can F it up is government demanding you continue to employ janitors instead of letting a contract to Bill.
How would you make money in this scenario? Own Musk, own electric AI trucks, own solar, (own Bill’s janitors), sell oil, sell coal, sell truck stops. Creative destruction is unstoppable so don’t try to stop it in fact ride it into the future. Riding it into the future requires giving up an inferior past. I put in the part about my Grandpa’s because it shows how even with a 2nd grade and a 8th grade education creativity and perseverance is limitless.
Not saying the above is Elon Musk’s plan. It would be my plan.